SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ---------- FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2005 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to Commission File Number 1-5721 LEUCADIA NATIONAL CORPORATION (Exact name of registrant as specified in its Charter) New York 13-2615557 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 315 Park Avenue South, New York, New York 10010-3607 (Address of principal executive offices) (Zip Code) (212) 460-1900 (Registrant's telephone number, including area code) N/A (Former name, former address and former fiscal year, if changed since last report) ---------------------- Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES X NO ------- ------- Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). YES X NO -------- ------- APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding of each of the issuer's classes of common stock, at July 29, 2005: 107,685,578.
PART I - FINANCIAL INFORMATION Item 1. Financial Statements. LEUCADIA NATIONAL CORPORATION AND SUBSIDIARIES Consolidated Balance Sheets June 30, 2005 and December 31, 2004 (Dollars in thousands, except par value) <TABLE> <CAPTION> June 30, December 31, 2005 2004 ------------- ----------- (Unaudited) <S> <C> <C> ASSETS Current assets: Cash and cash equivalents $ 517,529 $ 486,948 Investments 961,855 1,106,322 Trade, notes and other receivables, net 386,165 414,552 Prepaids and other current assets 172,891 52,127 ----------- ----------- Total current assets 2,038,440 2,059,949 Non-current investments 786,812 726,782 Notes and other receivables, net 12,303 16,906 Intangible assets, net and goodwill 92,025 1,472 Deferred tax asset, net 1,080,114 -- Other assets 192,601 201,624 Property, equipment and leasehold improvements, net 1,363,587 1,332,876 Investments in associated companies 452,602 460,794 ----------- ----------- Total $ 6,018,484 $ 4,800,403 =========== =========== LIABILITIES Current liabilities: Trade payables and expense accruals $ 399,570 $ 407,350 Deferred revenue 55,850 52,632 Other current liabilities 123,497 94,956 Customer banking deposits due within one year 10,812 18,472 Debt due within one year 63,253 68,237 Income taxes payable 18,396 17,690 ----------- ----------- Total current liabilities 671,378 659,337 Long-term deferred revenue 166,916 161,206 Other non-current liabilities 206,185 213,309 Non-current customer banking deposits 5,089 6,119 Long-term debt 1,460,445 1,483,504 ----------- ----------- Total liabilities 2,510,013 2,523,475 ----------- ----------- Commitments and contingencies Minority interest 15,355 18,275 ----------- ----------- SHAREHOLDERS' EQUITY Common shares, par value $1 per share, authorized 300,000,000 shares; 107,685,578 and 107,600,403 shares issued and outstanding, after deducting 42,374,172 and 42,399,597 shares held in treasury 107,686 107,600 Additional paid-in capital 599,805 598,504 Accumulated other comprehensive income 95,490 136,138 Retained earnings 2,690,135 1,416,411 ----------- ----------- Total shareholders' equity 3,493,116 2,258,653 ----------- ----------- Total $ 6,018,484 $ 4,800,403 =========== =========== </TABLE> See notes to interim consolidated financial statements. 2
LEUCADIA NATIONAL CORPORATION AND SUBSIDIARIES Consolidated Statements of Operations For the periods ended June 30, 2005 and 2004 (In thousands, except per share amounts) (Unaudited) <TABLE> <CAPTION> For the Three Month For the Six Month Period Ended June 30, Period Ended June 30, --------------------- --------------------- 2005 2004 2005 2004 ---- ---- ---- ---- <S> <C> <C> <C> <C> Revenues and Other Income: Telecommunications $ 458,642 $ 395,414 $ 880,137 $ 776,393 Healthcare 60,977 64,044 128,415 127,271 Manufacturing 88,051 16,683 108,925 30,065 Investment and other income 45,893 41,060 96,816 83,930 Net securities gains 46,949 52,346 47,004 61,618 ----------- --------- ----------- ----------- 700,512 569,547 1,261,297 1,079,277 ----------- --------- ----------- ----------- Expenses: Cost of sales: Telecommunications 323,708 285,514 626,727 572,291 Healthcare 51,328 52,281 107,792 104,067 Manufacturing 76,412 11,831 91,121 21,527 Interest 25,033 24,612 49,842 45,482 Salaries and incentive compensation 54,733 45,584 99,500 88,724 Depreciation and amortization 48,667 58,597 95,183 121,197 Selling, general and other expenses 78,903 60,172 157,315 130,227 ----------- --------- ----------- ----------- 658,784 538,591 1,227,480 1,083,515 ----------- --------- ----------- ----------- Income (loss) from continuing operations before income taxes and equity in income of associated companies 41,728 30,956 33,817 (4,238) Income taxes (1,107,460) (1,264) (1,106,836) (1,006) ----------- --------- ----------- ----------- Income (loss) from continuing operations before equity in income of associated companies 1,149,188 32,220 1,140,653 (3,232) Equity in income of associated companies, net of taxes 67,345 4,151 78,493 28,132 ----------- --------- ----------- ----------- Income from continuing operations 1,216,533 36,371 1,219,146 24,900 Loss from discontinued operations, net of taxes - (4,633) -- (5,114) Gain on disposal of discontinued operations, net of taxes 54,578 2,237 54,578 2,237 ----------- --------- ---------- ----------- Net income $ 1,271,111 $ 33,975 $ 1,273,724 $ 22,023 =========== ========= =========== =========== Basic earnings (loss) per common share: Income from continuing operations $11.30 $ .34 $11.32 $.23 Loss from discontinued operations -- (.04) -- (.04) Gain on disposal of discontinued operations .51 .02 .51 .02 ------ ----- ------ ---- Net income $11.81 $ .32 $11.83 $.21 ====== ===== ====== ==== Diluted earnings (loss) per common share: Income from continuing operations $10.56 $ .34 $10.62 $.23 Loss from discontinued operations -- (.04) -- (.04) Gain on disposal of discontinued operations .47 .02 .47 .02 ------ ----- ------ ---- Net income $11.03 $ .32 $11.09 $.21 ====== ===== ====== ==== </TABLE> See notes to interim consolidated financial statements. 3
LEUCADIA NATIONAL CORPORATION AND SUBSIDIARIES Consolidated Statements of Cash Flows For the six months ended June 30, 2005 and 2004 (In thousands) (Unaudited) <TABLE> <CAPTION> 2005 2004 ---- ---- <S> <C> <C> Net cash flows from operating activities: Net income $ 1,273,724 $ 22,023 Adjustments to reconcile net income to net cash provided by operations: Deferred income tax provision (benefit) (1,110,000) 10,752 Depreciation and amortization of property, equipment and leasehold improvements 97,416 124,564 Other amortization 1,392 1,127 Provision for doubtful accounts 3,605 (6,542) Net securities gains (47,004) (61,618) Equity in income of associated companies (79,223) (43,280) Distributions from associated companies 89,245 20,948 Gain on disposal of real estate, property and equipment, loan receivables and other assets (21,614) (16,197) Gain on disposal of discontinued operations (56,578) (2,237) Investments classified as trading, net 18,537 11,608 Net change in: Trade, notes and other receivables 77,420 28,195 Prepaids and other assets (32,347) (14,091) Trade payables and expense accruals (11,882) 13,236 Other liabilities (10,586) 7,559 Deferred revenue (8,735) (1,668) Income taxes payable 674 2,954 Other (97) (1,508) ----------- ---------- Net cash provided by operating activities 183,947 95,825 ----------- ---------- Net cash flows from investing activities: Acquisition of property, equipment and leasehold improvements (65,596) (48,074) Acquisitions of and capital expenditures for real estate investments (6,855) (5,193) Proceeds from disposals of real estate, property and equipment, and other assets 29,079 25,467 Proceeds from sale of discontinued operations 95,160 -- Principal collections on loan receivables 762 37,280 Proceeds from sale of loan receivables -- 149,042 Acquisitions, net of cash acquired (177,947) -- Advances on notes receivables (100) (400) Collections on notes receivables 1,721 26,868 Investments in associated companies (4,180) (51,422) Distributions from associated companies 130 -- Purchases of investments (other than short-term) (1,587,206) (1,202,857) Proceeds from maturities of investments 607,759 402,225 Proceeds from sales of investments 994,387 567,756 ----------- ---------- Net cash used for investing activities (112,886) (99,308) ----------- ---------- Net cash flows from financing activities: Net change in customer banking deposits (8,658) (81,002) Issuance of debt 21,612 437,598 Reduction of debt (51,814) (6,182) Issuance of common shares 1,387 1,812 ----------- ---------- Net cash provided by (used for) financing activities (37,473) 352,226 ----------- ---------- Effect of foreign exchange rate changes on cash (3,007) (112) ----------- ---------- Net increase in cash and cash equivalents 30,581 348,631 Cash and cash equivalents at January 1, 486,948 214,390 ----------- ---------- Cash and cash equivalents at June 30, $ 517,529 $ 563,021 =========== ========== See notes to interim consolidated financial statements. </TABLE> 4
LEUCADIA NATIONAL CORPORATION AND SUBSIDIARIES Consolidated Statements of Changes in Shareholders' Equity For the six months ended June 30, 2005 and 2004 (In thousands, except par value) (Unaudited) <TABLE> <CAPTION> Common Accumulated Shares Additional Other $1 Par Paid-In Comprehensive Retained Value Capital Income (Loss) Earnings Total ----- ------- ------------- -------- ----- <S> <C> <C> <C> <C> <C> Balance, January 1, 2004 $ 106,235 $577,863 $152,251 $ 1,297,812 $2,134,161 ---------- Comprehensive loss: Net change in unrealized gain (loss) on investments, net of taxes of $10,545 (22,421) (22,421) Net change in unrealized foreign exchange gain (loss), net of taxes of $504 (1,072) (1,072) Net change in unrealized gain (loss) on derivative instruments, net of taxes of $297 633 633 Net income 22,023 22,023 ---------- Comprehensive loss (837) ---------- Exercise of options to purchase common shares 108 1,704 1,812 --------- -------- -------- ----------- ---------- Balance, June 30, 2004 $ 106,343 $579,567 $129,391 $ 1,319,835 $2,135,136 ========= ======== ======== =========== ========== Balance, January 1, 2005 $ 107,600 $598,504 $136,138 $ 1,416,411 $2,258,653 ---------- Comprehensive income: Net change in unrealized gain (loss) on investments, net of taxes of $0 (29,639) (29,639) Net change in unrealized foreign exchange gain (loss), net of taxes of $0 (13,136) (13,136) Net change in unrealized gain (loss) on derivative instruments, net of taxes of $0 2,127 2,127 Net income 1,273,724 1,273,724 ---------- Comprehensive income 1,233,076 ---------- Exercise of options to purchase common shares 86 1,301 1,387 --------- -------- -------- ----------- ---------- Balance, June 30, 2005 $ 107,686 $599,805 $ 95,490 $ 2,690,135 $3,493,116 ========= ======== ======== =========== ========== </TABLE> See notes to interim consolidated financial statements. 5
LEUCADIA NATIONAL CORPORATION AND SUBSIDIARIES Notes to Interim Consolidated Financial Statements 1. The unaudited interim consolidated financial statements, which reflect all adjustments (consisting of normal recurring items or items discussed herein) that management believes necessary to present fairly results of interim operations, should be read in conjunction with the Notes to Consolidated Financial Statements (including the Summary of Significant Accounting Policies) included in the Company's audited consolidated financial statements for the year ended December 31, 2004, which are included in the Company's Annual Report filed on Form 10-K, as amended by Form 10-K/A, for such year (the "2004 10-K"). Results of operations for interim periods are not necessarily indicative of annual results of operations. The consolidated balance sheet at December 31, 2004 was extracted from the audited annual financial statements and does not include all disclosures required by accounting principles generally accepted in the United States of America ("GAAP") for annual financial statements. Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"), establishes a fair value method for accounting for stock-based compensation plans, either through recognition in the statements of operations or disclosure. As permitted, the Company applies APB Opinion No. 25 and related Interpretations in accounting for its plans. Accordingly, no compensation cost has been recognized in the statements of operations for its stock-based compensation plans. Had compensation cost for the Company's stock option plans been recorded in the statements of operations consistent with the provisions of SFAS 123, the Company's results of operations would not have been materially different from that reported. In April 2005, the Securities and Exchange Commission amended the effective date of Statement of Financial Accounting Standards No. 123R, "Share-Based Payment" ("SFAS 123R"), from the first interim or annual period after June 15, 2005 to the beginning of the next fiscal year that begins after June 15, 2005. The Company is currently evaluating the impact of SFAS 123R on its consolidated financial statements. In May 2005, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 154, "Accounting Changes and Error Corrections-a replacement of APB Opinion No. 20 and FASB Statement No. 3" ("SFAS 154"), which is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. SFAS 154 applies to all voluntary changes in accounting principles, and changes the accounting and reporting requirements for a change in accounting principle. SFAS 154 requires retrospective application to prior periods' financial statements of a voluntary change in accounting principle unless doing so is impracticable. APB 20 previously required that most voluntary changes in accounting principle be recognized by including in net income of the period in which the change occurred the cumulative effect of changing to the new accounting principle. SFAS 154 also requires that a change in depreciation, amortization, or depletion method for long-lived, nonfinancial assets be accounted for as a change in accounting estimate effected by a change in accounting principle. SFAS 154 carries forward without change the guidance in APB 20 for reporting the correction of an error in previously issued financial statements, a change in accounting estimate and a change in reporting entity, as well as the provisions of SFAS 3 that govern reporting accounting changes in interim financial statements. The Company is currently evaluating the impact of SFAS 154 on its consolidated financial statements, but does not expect that the impact will be material. In March 2005, the FASB issued FASB Interpretation No. 47, "Accounting for Conditional Asset Retirement Obligations" ("FIN 47"), which is effective for fiscal years ending after December 15, 2005. FIN 47 clarifies that the term conditional asset retirement obligation as used in FASB Statement No. 143, "Accounting for Asset Retirement Obligations", refers to a legal obligation to perform an asset retirement activity in which the timing and/or method of settlement are conditional on a future event that may or may not be within the control of the entity. Under FIN 47, an entity is required to recognize a liability for the fair value of a conditional asset retirement obligation if the fair value of the liability can be reasonably estimated. The fair value of a liability for the conditional asset retirement obligation should be recognized when incurred - generally upon acquisition, construction, or development and/or through the normal operation of the asset. The Company is currently evaluating the impact of FIN 47 on its consolidated financial statements, but does not expect that the impact will be material. 6
Notes to Interim Consolidated Financial Statements, continued Certain amounts for prior periods have been reclassified to reflect as discontinued operations a commercial real estate property and the Company's geothermal power business, which were sold during the fourth quarter of 2004, and to be consistent with the 2005 presentation. 2. In accordance with Financial Accounting Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS 144"), the Company evaluates its long-lived assets for impairment whenever events or changes in circumstances indicate, in management's judgment, that the carrying value of such assets may not be recoverable. When testing for impairment, the Company groups its long-lived assets with other assets and liabilities at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities (or asset group). The determination of whether an asset group is recoverable is based on management's estimate of undiscounted future cash flows directly attributable to the asset group as compared to its carrying value. If the carrying amount of the asset group is greater than the undiscounted cash flows, an impairment loss would be recognized for the amount by which the carrying amount of the asset group exceeds its estimated fair value. As more fully described in the 2004 10-K, on January 31, 2005, SBC Communications Inc. ("SBC") announced that it would buy AT&T Corp., and announced its intention to migrate the services provided by WilTel to the AT&T network. Since SBC is WilTel's largest customer, accounting for 70% of the Network segment's 2005 telecommunications revenues, the Company concluded that the SBC announcement is an event which requires the Company to assess the carrying value of WilTel's long-lived assets for impairment, principally property and equipment. Since the event which gave rise to the impairment review occurred on January 31, 2005, and is not reflective of a condition that existed as of December 31, 2004, the assessment of impairment was performed as part of the preparation of the Company's financial statements for the first quarter of 2005. Based on the assumptions described below, the Company concluded that an impairment charge was not required. The Company determined that WilTel's fiber optic communications network is the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities. The asset group is primarily composed of fiber optic cable, conduit, rights of way, optronics and certain buildings and related improvements. These assets are used together to generate joint cash flows. The Company has determined that the primary asset of the group is fiber optic cable, which has a remaining weighted average useful life of 16 years. The fiber optic cable is considered to be the primary asset of the group as it is the most significant component of the group, the principal asset from which the asset group derives its cash flow generating capacity, would cost the most to replace and without which most of the assets in the group would not have been acquired. The determination of the primary asset of the asset group is significant because estimated cash flows used to test for recoverability are based on the estimated remaining useful life of the primary asset. The carrying value of the asset group that was tested for impairment was approximately $920,000,000. The Company utilized WilTel's internal estimates of future cash flows from all of its customers over the remaining useful life of the primary asset. These assumptions reflected estimated future operating results and considered all relevant facts and circumstances. The economics and term of WilTel's future relationship with SBC were the most significant assumptions in the analysis. These assumptions were based upon the best information available; however, when the analysis was performed during the first quarter of 2005, negotiations between SBC and WilTel were not yet completed with respect to a transition services and pricing agreement and other matters. As more fully described below, WilTel and SBC subsequently entered into new agreements, and WilTel's new estimate of the cash flows that will be received from SBC pursuant to these agreements is greater than the amounts assumed for the first quarter impairment analysis. However, if WilTel's actual cash flows in the future are materially less than the amounts used for its impairment analysis, or other events occur which have a material adverse affect on WilTel's business or ability to generate future cash flows, the Company would have to prepare a new impairment analysis and may conclude that this asset group is impaired. 7
Notes to Interim Consolidated Financial Statements, continued 3. On June 15, 2005, WilTel and SBC reached an agreement, pursuant to which the existing alliance agreements between WilTel and SBC were terminated and a new Master Services Agreement and a Termination, Mutual Release and Settlement Agreement were entered into. In exchange for the termination of the existing alliance agreements and the exchange of mutual releases, WilTel will receive aggregate cash payments from SBC of $236,000,000. Of this amount, $11,000,000 is payable on January 3, 2006, and the balance is payable in twelve equal monthly installments beginning on the earlier of April 30, 2006 or the closing or termination of SBC's agreement to acquire AT&T. Under the new Master Services Agreement, SBC agreed to purchase WilTel services at the fixed prices that had been in effect on June 15, 2005, with minimum purchase commitments for on-net services of $600,000,000 for the period from January 1, 2005 through December 31, 2007, and $75,000,000 for the period from January 1, 2008 through December 31, 2009. If SBC fails to spend the required $600,000,000 or $75,000,000 during the respective designated periods, SBC will pay the amount of any deficiency and receive a credit equal to such amount to be used for future services. If SBC spends more than $600,000,000 during the initial three-year period, any excess will be credited toward the $75,000,000 commitment in the second period. SBC's minimum purchase commitments exclude access and off-net costs. However, for financial reporting purposes these costs are included as revenues, with offsetting amounts reported in telecommunications cost of sales, on the Company's consolidated statements of operations. As of June 30, 2005, approximately $120,000,000 of the minimum purchase commitments have been satisfied. Minimum purchase commitments are considered satisfied only when SBC has paid for the service provided, not when the service is recognized as revenue for financial reporting purposes. WilTel will also have the opportunity to earn up to an additional $50,000,000 by meeting quality of service performance criteria in 2006 and 2007. In addition, the Master Services Agreement provides that $18,000,000 of the $25,000,000 that SBC paid to WilTel in 2004 to pre-fund capital expenditures will be applied as a credit against amounts that would otherwise be payable for services during the second half of 2005, with the balance to be retained by WilTel. The amount received during 2004 was not recognized as income and has been reflected as a liability on the Company's consolidated balance sheet. WilTel will recognize the $236,000,000 of cash payments and the pre-funded capital expenditures that is not credited to SBC ($7,000,000) as other non-operating income, which is not a component of segment profit from operations. These amounts will be recognized as other income over time proportionally with the ratio of the minimum purchase commitments that have been satisfied subsequent to entering into the agreements with SBC, to the remaining minimum purchase commitment at June 15, 2005. For the periods ended June 30, 2005, $1,100,000 of this amount was reflected in other income. The quality of service performance criteria will be recognized as operating revenue during 2006 and 2007 as it is earned. SBC's January 2005 announcement to migrate its business from WilTel is considered an event which could reasonably be expected to have a "material adverse effect" as defined in WilTel's amended credit facility, and while WilTel can no longer access its $25,000,000 revolving credit facility it has no impact on the $358,100,000 of term loans under the agreement. However, the credit agreement provides for an event of default if there is any amendment, supplement, modification or termination of any WilTel contract or agreement that has had or could reasonably be expected to result in a material adverse effect on WilTel (as defined in the credit agreement). The Company does not believe that the new SBC agreements have had or could reasonably be expected to result in a material adverse effect on WilTel, particularly inasmuch as the Company believes that these new agreements, along with WilTel's existing liquidity, will provide WilTel with sufficient funds to pay its long-term debt obligations as they become due; as a result, the Company continues to classify the term loans as long-term debt. However, the Company has agreed with SBC that if WilTel's debt under its credit agreement becomes due and payable, and if WilTel does not have sufficient funds to pay the debt, the Company will advance to WilTel the incremental funds needed to pay the debt. 8
Notes to Interim Consolidated Financial Statements, continued 4. The Company records a valuation allowance to reduce its deferred tax asset to the amount that is more likely than not to be realized. If the Company were to determine that it would be able to realize its deferred tax asset in the future in excess of its net recorded amount, an adjustment would increase income in such period. Similarly, if the Company were to determine that it would not be able to realize all or part of its deferred tax asset in the future, an adjustment would be charged to income in such period. The Company also records reserves for contingent tax liabilities based on the Company's assessment of the probability of successfully sustaining its tax filing positions. As more fully discussed in the 2004 10-K, at acquisition the Company established a valuation allowance that reserved for substantially all of WilTel's net deferred tax asset, because the Company could not demonstrate it would have the future taxable income necessary to realize that asset. The Company's projections of consolidated taxable income and its assessment of the need for a full valuation allowance for the deferred tax asset had been significantly influenced by the fact that it had not yet generated positive cumulative pre-tax income over a period of years on a pro forma combined basis with WilTel, and the uncertainty of WilTel's relationship with SBC in the future. During the second quarter of 2005, WilTel entered into new agreements with SBC that significantly reduced uncertainty surrounding WilTel's future profitability. Additionally, taxable income from the Company's other operations and investments, when added to WilTel's on a pro forma combined basis, have now achieved positive cumulative pre-tax income for the Company. The Company has prepared updated projections of future taxable income and has concluded that it is more likely than not that it will have future taxable income sufficient to realize a portion of the Company's net deferred tax asset, and in June 2005 reversed $1,110,000,000 of the valuation allowance as a credit to income tax expense. After the adjustment, the remaining balance in the valuation allowance as of June 30, 2005 is approximately $950,000,000. For the remainder of 2005, the Company does not expect to record any material federal income tax provision; however, in future years the Company will record income tax provisions equal to its effective income tax rate, unless there is a further adjustment to the valuation allowance (see below). The Company's conclusion that a portion of the deferred tax asset was more likely than not to be realizable was strongly influenced by its historical ability to generate significant amounts of taxable income. The Company's estimate of future taxable income considered all available evidence, both positive and negative, about its current operations and investments, included an aggregation of individual projections for each material operation and investment, incorporated the assumptions used by WilTel for its impairment analysis (updated for the new SBC agreements) and included all future years (through 2024) that the Company estimated it would have available net operating loss carryforwards. Over the projection period, the Company assumed that its readily available cash, cash equivalents and marketable securities would provide returns equivalent to the returns expected to be provided by the Company's existing operations and investments, except for certain amounts assumed to be invested on a short-term basis to meet the Company's liquidity needs. The Company believes that its estimate of future taxable income is reasonable but inherently uncertain, and if its current or future operations and investments generate taxable income greater than the projected amounts, further adjustments to reduce the valuation allowance are possible. Conversely, if the Company realizes unforeseen material losses in the future, or its ability to generate future taxable income necessary to realize a portion of the deferred tax asset is materially reduced, additions to the valuation allowance could be recorded. For the periods ended June 30, 2004, the Company has recorded a net federal income tax provision on income from continuing operations, inclusive of a federal tax provision netted against equity in income of associated companies. The provision for federal income tax on income from continuing operations is fully offset by federal income tax benefits recognized on losses in other comprehensive income and losses from discontinued operations. As a result, when all components of income are aggregated there is no net federal income tax expense recorded for the periods ended June 30, 2004. Income taxes for the 2004 periods also include a provision for state income taxes. 9
Notes to Interim Consolidated Financial Statements, continued 5. Results of operations for the Company's segments are reflected from the date of acquisition. Except for the telecommunications segments of WilTel, the primary measure of segment operating results and profitability used by the Company is income (loss) from continuing operations before income taxes and equity in income (losses) of associated companies. For WilTel's segments, segment profit from operations is the primary performance measure of segment operating results and profitability. WilTel defines segment profit from operations as income before income taxes, interest expense, investment income, depreciation and amortization expense and other non-operating income and expense. The following information reconciles segment profit from operations of the Network and Vyvx segments to the most comparable GAAP measure, which is used for all other reportable segments, for the three and six month periods ended June 30, 2005 and 2004 (in thousands): <TABLE> <CAPTION> For the Three Month Period Ended June 30, ----------------------------------------------------- 2005 2004 -------------------------- ----------------------- Network Vyvx Network Vyvx ------- ---- ------- ---- <S> <C> <C> <C> <C> Segment profit from operations (1) (3) $ 49,222 $ 8,346 $ 31,891 $ 8,713 Depreciation and amortization expense (40,047) (1,147) (51,117) (2,174) Interest income (expense), net (2) (6,645) 1,018 (7,047) (529) Other non-operating income (expense), net (2) (5) 1,018 (8) (66) (6) ---------- --------- --------- -------- Income (loss) from continuing operations before income taxes and equity in income of associated companies $ 3,548 $ 8,209 $ (26,339) $ 6,004 ========== ========= ========= ======== For the Six Month Period Ended June 30, --------------------------------------------------- 2005 2004 -------------------------- ----------------------- Network Vyvx Network Vyvx ------- ---- ------- ---- Segment profit from operations (1) (3) $ 98,061 $ 15,348 $ 46,350 $ 15,064 Depreciation and amortization expense (81,143) (2,279) (105,662) (4,462) Interest income (expense), net (2) (4) (11,902) 2,237 (13,602) (1,085) Other non-operating income (expense), net (2) (5) 775 (32) 2,938 14 ---------- --------- --------- -------- Income (loss) from continuing operations before income taxes and equity in income of associated companies $ 5,791 $ 15,274 $ (69,976) $ 9,531 ========== ========= ========= ======== </TABLE> (1) Reflects intersegment charges from Network to Vyvx of $4,400,000 and $4,600,000 for the three month periods ended June 30, 2005 and 2004, respectively, and $8,600,000 and $9,100,000 for the six month periods ended June 30, 2005 and 2004, respectively. Also reflects intersegment charges of $500,000 from Network to ATX for the 2005 periods. (2) If items in these categories cannot be directly attributed to a particular WilTel segment, they are allocated to each segment based upon a formula that considers each segment's revenues, property and equipment and headcount. (3) For Network, for the three and six month periods ended June 30, 2005, includes $7,900,000 from the termination of a dark fiber contract and related maintenance services for which Network will not have to perform any remaining services and for which it has been paid; for the six month period ended June 30, 2005, includes gains of $13,000,000 from sales of operating assets, principally undersea cable assets. (4) For Vyvx for the six month period ended June 30, 2005, includes a bankruptcy claim distribution of $1,600,000 received for a security with no book value. (5) For the three and six month periods ended June 30, 2005, includes $1,100,000 related to the new agreements with SBC, which is discussed in Note 3. For the six month period ended June 30, 2004, includes a pre-tax gain of $2,800,000 related to cash and securities received in excess of the book value of secured claims in a customer's bankruptcy. Certain information concerning the Company's segments for the three and six month periods ended June 30, 2005 and 2004 is presented in the following table. 10
Notes to Interim Consolidated Financial Statements, continued <TABLE> <CAPTION> For the Three Month For the Six Month Period Ended June 30, Period Ended June 30, --------------------- --------------------- 2005 2004 2005 2004 ---- ---- ---- ---- (In thousands) <S> <C> <C> <C> <C> Revenues and other income (a): Telecommunications: Network (b) $ 416,205 $ 369,698 $ 829,287 $ 731,873 Vyvx 30,575 31,421 61,163 59,384 ATX Communications, Inc. ("ATX") 30,655 -- 30,655 -- Healthcare Services 61,080 64,068 128,958 127,315 Banking and Lending 1,669 11,183 3,067 19,890 Manufacturing: Plastics manufacturing 24,624 16,675 45,443 30,076 Idaho Timber Corporation ("ITC") 63,532 -- 63,532 -- Domestic Real Estate 7,838 9,458 17,292 25,815 Other Operations 8,426 7,313 15,126 14,952 Corporate (c) 60,841 64,312 75,887 79,044 Intersegment elimination (d) (4,933) (4,581) (9,113) (9,072) --------- --------- ---------- ---------- Total consolidated revenues and other income $ 700,512 $ 569,547 $1,261,297 $1,079,277 ========= ========= ========== ========== Income (loss) from continuing operations before income taxes and equity in income of associated companies: Telecommunications: Network (d) $ 3,548 $ (26,339) $ 5,791 $ (69,976) Vyvx (d) 8,209 6,004 15,274 9,531 ATX (d) (719) -- (719) -- Healthcare Services 849 5,405 2,205 7,788 Banking and Lending 689 9,252 688 14,566 Manufacturing: Plastics manufacturing 4,677 2,336 7,945 3,262 ITC (351) -- (351) -- Domestic Real Estate 1,130 1,220 542 9,115 Other Operations (1,620) (965) (5,259) (812) Corporate (c) 25,316 34,043 7,701 22,288 --------- --------- ---------- ---------- Total consolidated income (loss) from continuing operations before income taxes and equity in income of associated companies $ 41,728 $ 30,956 $ 33,817 $ (4,238) ========= ========= ========== ========== </TABLE> (a) Revenues and other income for each segment include amounts for services rendered and products sold, as well as segment reported amounts classified as investment and other income and net securities gains on the Company's consolidated statements of operations. (b) Includes services provided to SBC of $281,600,000 and $261,600,000, respectively, for the three month periods ended June 30, 2005 and 2004, and $560,700,000 and $500,000,000, respectively, for the six month periods ended June 30, 2005 and 2004. In addition, for the three and six month periods ended June 30, 2005, includes $1,100,000 of non-operating income related to the new agreements with SBC, which is discussed in Note 3. (c) Includes net securities gains of $46,900,000 and $52,500,000, respectively, for the three month periods ended June 30, 2005 and 2004, and $47,700,000 and $61,500,000, respectively, for the six month periods ended June 30, 2005 and 2004. 11
Notes to Interim Consolidated Financial Statements, continued (d) Eliminates intersegment revenues billed from Network to Vyvx of $4,400,000 and $4,600,000 for the three month periods ended June 30, 2005 and 2004, respectively, and $8,600,000 and $9,100,000 for the six month periods ended June 30, 2005 and 2004, respectively, and intersegment revenues billed from Network to ATX of $500,000 for the 2005 periods. However, the intersegment revenues are included in the calculation to determine segment profit from operations and income (loss) from continuing operations for each of Network, Vyvx and ATX. For the three month periods ended June 30, 2005 and 2004, income from continuing operations has been reduced by depreciation and amortization expenses of $52,800,000 and $61,200,000, respectively; such amounts are primarily comprised of Corporate ($2,700,000 and $3,500,000, respectively), plastics manufacturing ($1,800,000 and $1,400,000, respectively), ITC manufacturing ($2,400,000 in 2005) and amounts related to WilTel's segments, which are disclosed above. For the six month periods ended June 30, 2005 and 2004, income from continuing operations has been reduced by depreciation and amortization expenses of $102,500,000 and $126,500,000, respectively; such amounts are primarily comprised of Corporate ($5,300,000 and $6,900,000, respectively), plastics manufacturing ($3,400,000 and $2,600,000, respectively), ITC manufacturing ($2,400,000 in 2005) and amounts related to WilTel's segments which are disclosed above. Depreciation and amortization expenses for other segments are not material. For the three month periods ended June 30, 2005 and 2004, income from continuing operations has been reduced by interest expense of $25,000,000 and $24,600,000, respectively; such amounts are primarily comprised of Corporate ($15,600,000 and $14,200,000, respectively), healthcare services ($800,000 and $500,000, respectively), banking and lending ($400,000 and $700,000, respectively) and amounts related to WilTel's segments ($7,900,000 and $8,600,000, respectively). For the six month periods ended June 30, 2005 and 2004, income from continuing operations has been reduced by interest expense of $49,800,000 and $45,500,000, respectively; such amounts are primarily comprised of Corporate ($31,200,000 and $24,300,000, respectively), healthcare services ($1,500,000 and $1,000,000, respectively), banking and lending ($800,000 and $1,800,000, respectively), and amounts related to WilTel's segments ($15,300,000 and $17,100,000, respectively). Interest expense for other segments is not material. 6. The following tables provide summarized data with respect to significant investments in associated companies accounted for under the equity method of accounting for the periods the investments were owned by the Company. The information is provided for those investments whose relative significance to the Company could result in the Company including separate audited financial statements for such investments in its Annual Report on Form 10-K for the year ended December 31, 2005 (in thousands). <TABLE> <CAPTION> June 30, June 30, 2005 2004 ------------ ----------- <S> <C> <C> Olympus Re Holdings, Ltd.: Total revenues $ 260,200 $ 244,400 Income from continuing operations before extraordinary items 60,000 96,700 Net income 60,000 96,700 The Company's equity in net income 12,000 15,500 EagleRock Capital Partners (QP), LP: Total revenues $ (25,300) $ 7,400 Income (loss) from continuing operations before extraordinary items (26,100) 6,900 Net income (loss) (26,100) 6,900 The Company's equity in net income (loss) (19,500) 5,900 Jefferies Partners Opportunity Fund II, LLC: Total revenues $ 17,600 $ 13,900 Income from continuing operations before extraordinary items 16,400 12,600 Net income 16,400 12,600 The Company's equity in net income 11,100 8,700 </TABLE> 12
Notes to Interim Consolidated Financial Statements, continued 7. A summary of investments at June 30, 2005 and December 31, 2004 is as follows (in thousands): <TABLE> <CAPTION> June 30, 2005 December 31, 2004 ------------------------------ ----------------------------- Carrying Value Carrying Value Amortized and Estimated Amortized and Estimated Cost Fair Value Cost Fair Value ------------ ------------ --------- ---------- <S> <C> <C> <C> <C> Current Investments: Investments available for sale $ 857,183 $ 856,527 $ 939,175 $ 939,313 Trading securities 93,588 97,434 148,602 159,616 Other investments, including accrued interest income 7,894 7,894 7,393 7,393 --------- ---------- ---------- ---------- Total current investments $ 958,665 $ 961,855 $1,095,170 $1,106,322 ========= ========== ========== ========== Non-current Investments: Investments available for sale $ 493,178 $ 704,859 $ 432,207 $ 676,051 Other investments 81,953 81,953 50,731 50,731 --------- ---------- ---------- ---------- Total non-current investments $ 575,131 $ 786,812 $ 482,938 $ 726,782 ========= ========== ========== ========== </TABLE> 8. A summary of intangible assets, net and goodwill at June 30, 2005 and December 31, 2004 is as follows (in thousands): <TABLE> <CAPTION> June 30, December 31, 2005 2004 ------------- ---------- <S> <C> <C> Customer relationships, net of accumulated amortization of $2,113 and $491 $ 61,488 $ 1,472 Trademarks and tradename, net of accumulated amortization of $101 5,059 -- Patents, net of accumulated amortization of $65 2,265 -- Software, net of accumulated amortization of $191 4,909 -- Other intangible assets, net of accumulated amortization of $188 1,939 -- Goodwill 16,365 -- ----------- -------- $ 92,025 $ 1,472 =========== ======== </TABLE> The net carrying amount of intangible assets increased due to acquisitions made during 2005, and are being amortized on a straight-line basis over their average useful lives. See Note 14 for further information. Amortization expense on intangible assets was $2,700,000 and $600,000, respectively, for the three month periods ended June 30, 2005 and 2004, and $3,000,000 and $1,100,000, respectively, for the six month periods ended June 30, 2005 and 2004. The estimated aggregate future amortization expense for the intangible assets for each of the next five years is as follows (in thousands): 2005 (for the remaining six months) - $4,900,000; 2006 - $9,800,000; 2007 - $8,600,000; 2008 - $8,100,000; and 2009 - $8,100,000. At June 30, 2005, goodwill was comprised of $4,800,000, $8,200,000 and $3,400,000 within the ATX telecommunications, plastics manufacturing and ITC manufacturing segments, respectively. 9. A summary of accumulated other comprehensive income (loss), net of taxes at June 30, 2005 and December 31, 2004 is as follows (in thousands): <TABLE> <CAPTION> June 30, December 31, 2005 2004 ---------- ----------- <S> <C> <C> Net unrealized gains on investments $ 123,557 $ 153,196 Net unrealized foreign exchange gains 1,173 14,309 Net unrealized losses on derivative instruments (1,628) (3,755) Net minimum pension liability (27,612) (27,612) ---------- ---------- $ 95,490 $ 136,138 ========== ========== </TABLE> 13
Notes to Interim Consolidated Financial Statements, continued 10. Investment and other income includes changes in the fair values of derivative financial instruments of $(1,300,000) and $2,500,000, respectively, for the three month periods ended June 30, 2005 and 2004, and $(200,000) and $1,300,000 respectively, for the six month periods ended June 30, 2005 and 2004. 11. Pension expense charged to operations for the three and six month periods ended June 30, 2005 and 2004 related to the defined benefit pension plan (other than WilTel's plan) included the following components (in thousands): <TABLE> <CAPTION> For the Three Month For the Six Month Period Ended June 30, Period Ended June 30, --------------------- --------------------- 2005 2004 2005 2004 ---- ---- ---- ---- <S> <C> <C> <C> <C> Interest cost $ 512 $ 531 $1,023 $1,063 Expected return on plan assets (229) (447) (457) (895) Actuarial loss 208 144 416 288 Amortization of prior service cost 1 -- 2 1 ------ ------ ------ ------ Net pension expense $ 492 $ 228 $ 984 $ 457 ====== ====== ====== ====== </TABLE> WilTel's pension expense charged to operations for the three and six month periods ended June 30, 2005 and 2004 related to the defined benefit pension plan included the following components (in thousands): <TABLE> <CAPTION> For the Three Month For the Six Month Period Ended June 30, Period Ended June 30, --------------------- --------------------- 2005 2004 2005 2004 ---- ---- ---- ---- <S> <C> <C> <C> <C> Interest cost $2,052 $1,612 $4,103 $3,224 Service cost 966 864 1,931 1,727 Expected return on plan assets (1,327) (961) (2,653) (1,921) Actuarial loss 11 -- 23 -- ------ ------ ------ ------ Net pension expense $1,702 $1,515 $3,404 $3,030 ======= ====== ====== ====== </TABLE> Employer contributions to WilTel's defined benefit pension plan were $4,500,000 during the first six months of 2005. Several subsidiaries provide certain healthcare and other benefits to certain retired employees under plans which are currently unfunded. The Company pays the cost of postretirement benefits as they are incurred. Amounts charged to expense were not material in each of the three and six month periods ended June 30, 2005 and 2004. 12. Per share amounts were calculated by dividing income (loss) by the sum of the weighted average number of common shares outstanding and, for diluted earnings (loss) per share, the incremental weighted average number of shares issuable upon exercise of outstanding options and warrants for the periods they were outstanding. In addition, the calculations of diluted earnings (loss) per share assume the 3 3/4% Convertible Notes had been converted into common shares for the periods they were outstanding and earnings increased for the interest on such notes, net of the income tax effect. The number of shares used to calculate basic earnings (loss) per share amounts was 107,652,000 and 106,320,000 for the three month periods ended June 30, 2005 and 2004, respectively, and 107,633,000 and 106,295,000 for the six month periods ended June 30, 2005 and 2004, respectively. The number of shares used to calculate diluted earnings (loss) per share amounts was 115,513,000 and 112,948,000 for the three month periods ended June 30, 2005 and 2004, respectively, and 115,509,000 and 107,217,000 for the six month periods ended June 30, 2005 and 2004, respectively. 14
Notes to Interim Consolidated Financial Statements, continued 13. Cash paid for interest and net income taxes paid (refunded) was $52,000,000 and $1,400,000, respectively, for the six month period ended June 30, 2005 and $38,000,000 and $(27,800,000), respectively, for the six month period ended June 30, 2004. 14. In February 2005, the plastics manufacturing segment acquired the assets of NSW, LLC U.S. ("NSW") for a purchase price of approximately $26,800,000, subject to working capital adjustments, and recorded an aggregate of $10,200,000 of intangible assets and $8,200,000 of goodwill. NSW has a manufacturing and distribution facility in Roanoke, Virginia, which manufactures a variety of products including produce and packaging nets, header label bags, case liners and heavy weight nets for drainage and erosion control purposes. The NSW intangible assets will be amortized on a straight-line basis over the following average useful lives: customer relationships - 16 years, trademarks and tradename - 19 years, patents - 15 years and other intangible assets - 5 years. The bankruptcy plan (the "Plan") of ATX Communications, Inc. and certain of its affiliates (collectively "ATX") was confirmed by the Bankruptcy Court for the Southern District of New York and became effective on April 22, 2005. The Company has consolidated ATX since the effective date of the Plan. ATX is an integrated communications provider that offers local exchange carrier and inter-exchange carrier telephone, Internet, high-speed data and other communications services to business and residential customers in targeted markets throughout the Mid-Atlantic and Midwest regions of the United States. ATX has entered into agreements to sell its Midwest region business and its internet service provider business; as of the date of acquisition these businesses were held for sale in the net amount of $14,500,000. In December 2003, the Company purchased all of ATX's debt obligations under its senior secured credit facility for $25,000,000. As contemplated by the Plan, in exchange for its investment in the credit facility the Company received 94.4% of the new common stock of the reorganized ATX and a new $25,000,000 senior secured note which bears interest at 10%. In addition, the Company provided ATX $5,000,000 of debtor-in-possession financing and $25,000,000 of exit financing to fund bankruptcy related payments and working capital requirements. On behalf of ATX, the Company also obtained cash collateralized letters of credit totaling $14,700,000 issued for the benefit of one of ATX's vendors. The requirement to provide the letters of credit will decline over a period of years, commencing in 2006. The aggregate purchase price for ATX was $56,300,000, which includes all the financing provided to ATX by the Company and acquisition expenses. Based upon its preliminary allocation of the purchase price, the Company has recorded ATX intangible assets of $20,400,000 and goodwill of $4,800,000. The intangible assets will be amortized on a straight-line basis over the following average useful lives: trademarks - 10 years, customer relationships - 7 years, software - 5 years, and other intangibles - 2 years. The Company will not finalize its allocation of the purchase price until an independent third-party appraisal of the fair value of the assets acquired is completed. When finalized, any changes to the preliminary purchase price allocation could result in changes to property and equipment, identifiable intangible assets and/or goodwill. However, the Company does not expect that its final allocation of the purchase price will be materially different from the preliminary allocation. In May 2005, the Company acquired Idaho Timber Corporation and certain affiliated entities ("ITC") for total cash consideration of $138,900,000, including working capital adjustments and expenses. The Company has consolidated ITC from the date of acquisition. ITC was a privately held corporation that is headquartered in Boise, Idaho, which "remanufactures" dimensional lumber, home center boards, 5/4" radius-edge decking and a number of specialized products. ITC operates ten facilities located throughout the United States, and its revenue is principally derived from the purchase of bundles of low-grade lumber on the spot market, and the conversion of that lumber into higher-grade lumber through sorting and minor rework. 15
Notes to Interim Consolidated Financial Statements, continued Based upon its preliminary allocation of the purchase price, the Company has recorded ITC intangible assets of $46,200,000 and goodwill of $3,400,000. The intangible assets will be amortized on a straight-line basis over the following average useful lives: customer relationships - 10 years, and other intangibles - 1 year. The Company will not finalize its allocation of the purchase price until an independent third-party appraisal of the fair value of the assets acquired is completed. When finalized, any changes to the preliminary purchase price allocation could result in changes to property and equipment, identifiable intangible assets and/or goodwill. However, the Company does not expect that its final allocation of the purchase price will be materially different from the preliminary allocation. Unaudited pro forma operating results for the Company, assuming the acquisitions of ATX and ITC had occurred as of the beginning of each period presented below are as follows (in thousands, except per share amounts): <TABLE> <CAPTION> For the Three Month For the Six Month Period Ended June 30, Period Ended June 30, --------------------- --------------------- 2005 2004 2005 2004 ---- ---- ---- ---- <S> <C> <C> <C> <C> Revenues $ 745,200 $ 719,600 $1,432,700 $1,362,100 Income before extraordinary items and cumulative effect of a change in accounting principles $1,268,300 $ 47,300 $1,274,600 $ 43,700 Net income $1,268,300 $ 47,300 $1,274,600 $ 43,700 Per Share: Basic $11.78 $.45 $11.84 $.41 Diluted $11.01 $.43 $11.10 $.41 </TABLE> Prior to its acquisition by the Company, during 2005 ITC recorded aggregate expenses of $6,500,000 for consulting and advisory fees, legal and accounting fees, incentive compensation and other items all related to ITC's efforts to sell the company. Substantially all of these costs are included in their historical results for the second quarter of 2005. Pro forma adjustments principally reflect the preliminary allocation of the purchase price to the difference between the fair value and book value of property and equipment, resulting in increases or decreases to historical depreciation expense, and the allocation to identifiable intangible assets discussed above, resulting in increased amortization expense. For ATX, the pro forma adjustments also include the elimination of net reorganization items, which principally resulted from a gain recognized upon the discharge of ATX indebtedness in bankruptcy, fresh start accounting adjustments and bankruptcy related professional fees, and the reversal of historical interest expense related to indebtedness that was discharged in bankruptcy. The increase or (decrease) to historical income from the pro forma adjustments is as follows (in thousands): <TABLE> <CAPTION> For the Three Month For the Six Month Period Ended June 30, Period Ended June 30, --------------------- --------------------- 2005 2004 2005 2004 ---- ---- ---- ---- <S> <C> <C> <C> <C> Depreciation and amortization expenses $ (200) $ (3,400) $ (5,400) $ (7,600) Reorganization items $ (3,500) $ 3,500 $ (1,000) $ 20,400 </TABLE> The unaudited pro forma data is not indicative of future results of operations or what would have resulted if the acquisitions of ATX and ITC had actually occurred as of the beginning of the periods presented. Unaudited pro forma data for NSW is not included as the amounts were not material. 15. In May 2005, the Company sold its 716-room Waikiki Beach hotel and related assets for an aggregate purchase price of $107,000,000, before closing costs and other required payments. After satisfaction of mortgage indebtedness on the hotel of $22,100,000 at closing, the Company received net cash proceeds of approximately $73,000,000, and recorded a pre-tax gain of $56,600,000 (reflected in discontinued operations). Historical operating results for the hotel have not been material. 16
Notes to Interim Consolidated Financial Statements, continued 16. In May 2005, an entity in which the Company has a non-controlling equity interest ("Union Square") sold its interest in an office complex located on Capitol Hill in Washington, D.C. and the Company recognized a pre-tax gain of $71,900,000. The gain is reported in the caption equity in income of associated companies. The Company's share of the net proceeds is $72,800,000, all of which was received except for $1,000,000 that remains in escrow and is expected to be received during the fourth quarter of 2005. 17. In May 2005, the Company's 72.1% owned subsidiary, MK Resources Company ("MK"), entered into a share purchase agreement with the Company and Inmet Mining Corporation ("Inmet"), a Canadian-based global mining company, that provides for Inmet's acquisition of 70% of MK's interest in Cobre Las Cruces, S.A. ("CLC"), a wholly-owned Spanish subsidiary of MK that holds the exploration and mineral rights to the Las Cruces copper deposit in the Pyrite Belt of Spain. Inmet will acquire the interest in CLC in exchange for 5,600,000 newly issued Inmet common shares. The Inmet shares will have the benefit of a registration rights agreement; however, the shares may not be transferred or sold to a third party until the earlier of four years from the closing date or the date on which the Company is no longer obligated under the guarantee discussed below. Although the Company does not currently believe it will record any loss on the sale at closing, any gain or loss recorded by the Company would be based upon the fair value of the Inmet stock on the date it is received. Closing of the transaction is subject to a number of conditions, including the Company's acquisition of the outstanding MK common shares that it doesn't already own, the execution of project financing commitments with third parties to provide for no less than $255,000,000 (including interest during construction), a 66 million euro bridge facility and other customary closing conditions. The Company has entered into a merger agreement with MK to acquire the remaining MK common shares for aggregate merger consideration of approximately 333,500 of the Company's common shares. MK has scheduled a shareholder meeting to vote on the merger on August 9, 2005, and since the agreement with Inmet requires the Company to vote its shares in favor of the merger, approval is assured. The Company and Inmet have also committed to provide financing to CLC which is estimated to be $159,000,000, of which the Company's share will be 30% ($32,300,000 of which has already been loaned), and the Company has agreed to provide a payment guarantee for 30% of the third party project financing until such time as the completion tests to be specified under the project financing have been achieved. 18. During the third quarter of 2005, the Company's banking and lending subsidiary sold its remaining customer deposits and surrendered its national bank charter. 17
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Interim Operations. The following should be read in conjunction with the Management's Discussion and Analysis of Financial Condition and Results of Operations included in the 2004 10-K. Liquidity and Capital Resources For the six month period ended June 30, 2005, net cash was provided by operations principally as a result of the collection of a receivable related to a former partnership interest, as discussed below, distributions from associated companies and a decrease in the Company's investment in the trading portfolio. For the six month period ended June 30, 2004, net cash was provided by operations principally as a result of distributions from associated companies, the pre-funding by SBC of certain of WilTel's capital expenditures, the refund of excess federal income tax payments, accrued but unpaid interest on debt and an increase in accounts payable due to the timing of payments. As of June 30, 2005, the Company's readily available cash, cash equivalents and marketable securities, excluding amounts held by its regulated subsidiary and non-regulated subsidiaries that are parties to agreements which restrict the payment of dividends, totaled $1,668,900,000. This amount is comprised of cash and short-term bonds and notes of the United States Government and its agencies of $939,500,000 (56.3%), the equity investment in White Mountains Insurance Group, Ltd. of $236,600,000 (14.2%) (which can be sold privately or otherwise in compliance with the securities laws and have the benefit of a registration rights agreement) and other publicly traded debt and equity securities aggregating $492,800,000 (29.5%). In June 2005, the Company's 8 1/4% senior subordinated notes, which had an outstanding principal amount of $19,100,000, matured. The Company repaid these notes and the related accrued interest with readily available cash resources. As of June 30, 2005, WilTel had aggregate cash and investments of $289,600,000, an increase of $49,900,000 from December 31, 2004. The increase during this period reflects WilTel's positive operating results, reduced by WilTel's capital expenditures of $44,000,000. Substantially all of WilTel's assets have been pledged to secure its outstanding long-term debt, principally to secure its obligations under its credit agreement ($358,100,000 outstanding as of June 30, 2005) and its mortgage debt ($59,900,000 outstanding at June 30, 2005). On June 15, 2005, WilTel and SBC reached an agreement, pursuant to which the existing alliance agreements between WilTel and SBC were terminated and a new Master Services Agreement and a Termination, Mutual Release and Settlement Agreement were entered into. In exchange for the termination of the existing alliance agreements and the exchange of mutual releases, WilTel will receive aggregate cash payments from SBC of $236,000,000. Of this amount, $11,000,000 is payable on January 3, 2006, and the balance is payable in twelve equal monthly installments beginning on the earlier of April 30, 2006 or the closing or termination of SBC's agreement to acquire AT&T. SBC also agreed to minimum purchase commitments for WilTel services and other performance based payments which are discussed in results of operations below. SBC's January 2005 announcement to migrate its business from WilTel is considered an event which could reasonably be expected to have a "material adverse effect" as defined in WilTel's amended credit facility, and while WilTel can no longer access its $25,000,000 revolving credit facility it has no impact on the $358,100,000 of term loans under the agreement. However, the credit agreement provides for an event of default if there is any amendment, supplement, modification or termination of any WilTel contract or agreement that has had or could reasonably be expected to result in a material adverse effect on WilTel (as defined in the credit agreement). The Company does not believe that the new SBC agreements have had or could reasonably be expected to result in a material adverse effect on WilTel, particularly inasmuch as the Company believes that these new agreements, along with WilTel's existing liquidity, will provide WilTel with sufficient funds to pay its long-term debt obligations as they become due; as a result, the Company continues to classify the term loans as long-term debt. However, the Company has agreed with SBC that if WilTel's debt under its credit agreement becomes due and payable, and if WilTel does not have sufficient funds to pay the debt, the Company will advance to WilTel the incremental funds needed to pay the debt. 18
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Interim Operations, continued. As more fully discussed in the 2004 10-K, WilTel plans to modify its operations in light of the anticipated loss of its major customer, including expanding its customer base and evaluating opportunities for consolidation. However, given the current economic condition of the telecommunications industry as a whole, WilTel does not believe it will be able to fully replace the revenues and profits generated by the SBC agreements in the near future, if ever. The Company believes there may be opportunities to increase Network's value through consolidation opportunities, and it is actively investigating those possibilities. WilTel is a party to various legal actions and claims, and has reserved $20,900,000 for the satisfaction of all litigation. Certain of these actions relate to the rights of way licensed to WilTel in connection with the installation of its fiber-optic cable and seek damages from WilTel for failure to obtain all necessary landowner consents. Additional right of way claims may be asserted against WilTel. The Company does not believe that the ultimate resolution of all claims, legal actions and complaints will have a material adverse effect upon WilTel's results of operations, although unfavorable outcomes could significantly impact WilTel's liquidity. As more fully described in the 2004 10-K, current operating activities at the banking and lending segment have been concentrated on maximizing returns on its investment portfolio, collecting and servicing its remaining loan portfolios and discharging deposit liabilities as they come due. During 2005, the Company's banking and lending subsidiary filed a formal plan with the Office of the Comptroller of the Currency to liquidate its operations and surrender its national bank charter. In the third quarter of 2005, the Company's banking and lending subsidiary sold its remaining customer deposits and surrendered its national bank charter. As of June 30, 2005, the banking and lending segment had outstanding loans of $3,500,000 and deposit liabilities of $15,900,000. As of December 31, 2004, the Company redeemed its interest in Pershing Square, L.P. ("Pershing"), a limited partnership that is authorized to engage in a variety of investing activities. The total amount due from Pershing of $71,300,000 was included in trade, notes and other receivables, net in the Company's consolidated balance sheet at December 31, 2004. Such amount was received in cash during the first quarter of 2005. In February 2005, the plastics manufacturing segment acquired the assets of NSW for approximately $26,800,000, subject to working capital adjustments. NSW has a manufacturing and distribution facility in Roanoke, Virginia, and for its year ended December 31, 2004 generated annual sales of approximately $20,000,000. Products manufactured by NSW include produce and packaging nets, header label bags, case liners and heavy weight nets for drainage and erosion control purposes. The funds for the acquisition were provided from the Company's readily available cash resources. In April 2005, the Company acquired ATX upon the effectiveness of its bankruptcy plan for approximately $56,300,000, including expenses, of which $25,300,000 was spent in 2005 and the balance was spent during 2003 and 2004. ATX is an integrated communications provider that offers local exchange carrier and inter-exchange carrier telephone, Internet, high-speed data and other communications services to business and residential customers in targeted markets throughout the Mid-Atlantic and Midwest regions of the United States. ATX has entered into agreements to sell its Midwest region business and its internet service provider business; as of the date of acquisition these businesses were held for sale in the net amount of $14,500,000. In May 2005, the Company acquired ITC for total cash consideration of $138,900,000, including working capital adjustments and expenses. ITC "remanufactures" dimensional lumber, home center boards, 5/4" radius-edge decking and a number of specialized products and operates ten facilities located throughout the United States. Its revenue is principally derived from the purchase of bundles of low-grade lumber on the spot market, and the conversion of that lumber into higher-grade lumber through sorting and minor rework. The funds for the acquisition were provided from the Company's readily available cash resources. 19
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Interim Operations, continued. In May 2005, the Company sold its 716-room Waikiki Beach hotel and related assets for an aggregate purchase price of $107,000,000 (before closing costs and other required payments). After satisfaction of mortgage indebtedness on the hotel of $22,100,000 at closing, the Company received net cash proceeds of approximately $73,000,000. In May 2005, an entity in which the Company has a non-controlling equity interest ("Union Square") sold its interest in an office complex located on Capitol Hill in Washington, D.C. The Company's share of the net proceeds is $72,800,000, all of which was received except for $1,000,000 that remains in escrow and is expected to be received during the fourth quarter of 2005. In May 2005, MK entered into a share purchase agreement with the Company and Inmet, a Canadian-based global mining company, which provides for Inmet's acquisition of 70% of MK's interest in CLC, a wholly-owned Spanish subsidiary of MK that holds the exploration and mineral rights to the Las Cruces copper deposit in the Pyrite Belt of Spain. Inmet will acquire the interest in CLC in exchange for 5,600,000 newly issued Inmet common shares. The Inmet shares will have the benefit of a registration rights agreement; however, the shares may not be transferred or sold to a third party until the earlier of four years from the closing date or the date on which the Company is no longer obligated under the guarantee discussed below. Closing of the transaction is subject to a number of conditions, including the Company's acquisition of the outstanding MK common shares that it doesn't already own, the execution of project financing commitments with third parties to provide for no less than $255,000,000 (including interest during construction), a 66 million euro bridge facility and other customary closing conditions. The Company has entered into a merger agreement with MK to acquire the remaining MK common shares for aggregate merger consideration of approximately 333,500 of the Company's common shares. MK has scheduled a shareholder meeting to vote on the merger on August 9, 2005, and since the agreement with Inmet requires the Company to vote its shares in favor of the merger, approval is assured. The Company and Inmet have also committed to provide financing to CLC which is estimated to be $159,000,000, of which the Company's share will be 30% ($32,300,000 of which has already been loaned), and the Company has agreed to provide a payment guarantee for 30% of the third party project financing until such time as the completion tests to be specified under the project financing have been achieved. Critical Accounting Estimates The Company's discussion and analysis of its financial condition and results of operations are based upon its consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of these financial statements requires the Company to make estimates and assumptions that affect the reported amounts in the financial statements and disclosures of contingent assets and liabilities. In its 2004 10-K, the Company identified certain areas as critical accounting estimates because they have the potential to have a material impact on the Company's financial statements, and because they are based on assumptions which are used in the accounting records to reflect, at a specific point in time, events whose ultimate outcome won't be known until a later date. On an on-going basis, the Company evaluates all of these estimates and assumptions. Impairment of Long-Lived Assets - In accordance with SFAS 144, the Company evaluates its long-lived assets for impairment whenever events or changes in circumstances indicate, in management's judgment, that the carrying value of such assets may not be recoverable. When testing for impairment, the Company groups its long-lived assets with other assets and liabilities at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities (or asset group). The determination of whether an asset group is recoverable is based on management's estimate of undiscounted future cash flows directly attributable to the asset group as compared to its carrying value. If the carrying amount of the asset group is greater than the undiscounted cash flows, an impairment loss would be recognized for the amount by which the carrying amount of the asset group exceeds its estimated fair value. 20
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Interim Operations, continued. As discussed above, on January 31, 2005, SBC announced that it would buy AT&T and announced its intention to migrate the services provided by WilTel to the AT&T network. Since SBC is WilTel's largest customer, accounting for 70% of the Network segment's 2005 telecommunications revenues, the Company concluded that the SBC announcement is an event which requires the Company to assess the carrying value of WilTel's long-lived assets for impairment, principally property and equipment. Since the event which gave rise to the impairment review occurred on January 31, 2005, and is not reflective of a condition that existed as of December 31, 2004, the assessment of impairment was performed as part of the preparation of the Company's financial statements for the first quarter of 2005. Based on the assumptions described below, the Company concluded that an impairment charge was not required. The Company determined that WilTel's fiber optic communications network is the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities. The asset group is primarily composed of fiber optic cable, conduit, rights of way, optronics and certain buildings and related improvements. These assets are used together to generate joint cash flows. The Company has determined that the primary asset of the group is fiber optic cable, which has a remaining weighted average useful life of 16 years. The fiber optic cable is considered to be the primary asset of the group as it is the most significant component of the group, the principal asset from which the asset group derives its cash flow generating capacity, would cost the most to replace and without which most of the assets in the group would not have been acquired. The determination of the primary asset of the asset group is significant because estimated cash flows used to test for recoverability are based on the estimated remaining useful life of the primary asset. The carrying value of the asset group that was tested for impairment was approximately $920,000,000. The Company utilized WilTel's internal estimates of future cash flows from all of its customers over the remaining useful life of the primary asset. These assumptions reflected estimated future operating results and considered all relevant facts and circumstances. The economics and term of WilTel's future relationship with SBC were the most significant assumptions in the analysis. These assumptions were based upon the best information available; however, when the analysis was performed during the first quarter of 2005, negotiations between SBC and WilTel were not yet completed with respect to a transition services and pricing agreement and other matters. As more fully described above, WilTel and SBC subsequently entered into new agreements, and WilTel's new estimate of the cash flows that will be received from SBC pursuant to these agreements is greater than the amounts assumed for the first quarter impairment analysis. However, if WilTel's actual cash flows in the future are materially less than the amounts used for its impairment analysis, or other events occur which have a material adverse affect on WilTel's business or ability to generate future cash flows, the Company would have to prepare a new impairment analysis and may conclude that this asset group is impaired. The Company's conclusion that an impairment charge was not required does not mean that the Company believes the fair value of the network asset group equals its current carrying value. Under FAS 144, an asset group is considered recoverable (and no impairment charge is recorded) if management's estimate of the direct cash flows that the asset group can generate is, on an undiscounted basis, greater than the carrying value. However, since the Company's estimate of the future cash flows is undiscounted and extends over 16 years, the determination of the fair value of the asset group would have to include, among other factors, discounting the gross cash flows to their net present value at an appropriate rate. Income Taxes - The Company records a valuation allowance to reduce its deferred tax asset to the amount that is more likely than not to be realized. If the Company were to determine that it would be able to realize its deferred tax asset in the future in excess of its net recorded amount, an adjustment would increase income in such period. Similarly, if the Company were to determine that it would not be able to realize all or part of its deferred tax asset in the future, an adjustment would be charged to income in such period. The Company also records reserves for contingent tax liabilities based on the Company's assessment of the probability of successfully sustaining its tax filing positions. 21
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Interim Operations, continued. As more fully discussed in the 2004 10-K, at acquisition the Company established a valuation allowance that reserved for substantially all of WilTel's net deferred tax asset, because the Company could not demonstrate it would have the future taxable income necessary to realize that asset. The Company's projections of consolidated taxable income and its assessment of the need for a full valuation allowance for the deferred tax asset had been significantly influenced by the fact that it had not yet generated positive cumulative pre-tax income over a period of years on a pro forma combined basis with WilTel, and the uncertainty of WilTel's relationship with SBC in the future. During the second quarter of 2005, WilTel entered into new agreements with SBC that significantly reduced uncertainty surrounding WilTel's future profitability. Additionally, taxable income from the Company's other operations and investments, when added to WilTel's on a pro forma combined basis, have now achieved positive cumulative pre-tax income for the Company. The Company has prepared updated projections of future taxable income and has concluded that it is more likely than not that it will have future taxable income sufficient to realize a portion of the Company's net deferred tax asset, and in June 2005 reversed $1,110,000,000 of the valuation allowance as a credit to income tax expense. After the adjustment, the remaining balance in the valuation allowance as of June 30, 2005 is approximately $950,000,000. For the remainder of 2005, the Company does not expect to record any material federal income tax provision; however, in future years the Company will record income tax provisions equal to its effective income tax rate, unless there is a further adjustment to the valuation allowance (see below). The Company's conclusion that a portion of the deferred tax asset was more likely than not to be realizable was strongly influenced by its historical ability to generate significant amounts of taxable income. The Company's estimate of future taxable income considered all available evidence, both positive and negative, about its current operations and investments, included an aggregation of individual projections for each material operation and investment, incorporated the assumptions used by WilTel for its impairment analysis (updated for the new SBC agreements) and included all future years (through 2024) that the Company estimated it would have available net operating loss carryforwards. Over the projection period, the Company assumed that its readily available cash, cash equivalents and marketable securities would provide returns equivalent to the returns expected to be provided by the Company's existing operations and investments, except for certain amounts assumed to be invested on a short-term basis to meet the Company's liquidity needs. The Company believes that its estimate of future taxable income is reasonable but inherently uncertain, and if its current or future operations and investments generate taxable income greater than the projected amounts, further adjustments to reduce the valuation allowance are possible. Conversely, if the Company realizes unforeseen material losses in the future, or its ability to generate future taxable income necessary to realize a portion of the deferred tax asset is materially reduced, additions to the valuation allowance could be recorded. The Company is required to record the adjustment to the deferred tax asset valuation allowance under generally accepted accounting principles. While the adjustment significantly increases the Company's June 2005 net worth (an increase of 47%), there is no current cash benefit to the Company. The adjustment will also result in the recording of material income tax expense in the future, even though there will be no material cash expenditure for income taxes. Further, while the adjustment results from the projection of taxable income over a long period of time, under generally accepted accounting principles the expected future tax savings are not discounted. As a result, this adjustment increases the Company's net worth attributable to tax savings before the Company has generated the taxable income necessary to realize those tax savings; when the tax savings are actually realized over time, net worth will be reduced by the recording of a deferred tax provision. Reflecting tax savings before the tax is actually saved results in the Company's balance sheet being less conservative than the Company would want it to be. However, this accounting policy is mandated by generally accepted accounting principles. 22
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Interim Operations, continued. Results of Operations The 2005 Periods Compared to the 2004 Periods Telecommunications - Network and Vyvx The following tables reconcile WilTel's segment profit from operations to income (loss) from continuing operations before income taxes for the three and six month periods ended June 30, 2005 and 2004. For WilTel's segments, segment profit from operations is the primary performance measure of segment operating results and profitability. WilTel defines segment profit from operations as income before income taxes, interest expense, investment income, depreciation and amortization expense and other non-operating income and expense. <TABLE> <CAPTION> For the Three Month Period Ended June 30, 2005 2004 ------------------------------------ ------------------------------------ Network Vyvx Total Network Vyvx Total ------- ----------- ---------- ----------- ----------- --------- (In thousands) <S> <C> <C> <C> <C> <C> <C> Operating revenues (1) (3) $ 407,100 $ 30,400 $ 437,500 $ 364,100 $ 31,400 $ 395,500 ========== ========== ========= =========== ========= ========= Segment profit from operations (3) $ 49,200 $ 8,400 $ 57,600 $ 31,900 $ 8,700 $ 40,600 Depreciation and amortization expense (40,000) (1,200) (41,200) (51,100) (2,200) (53,300) Interest income (expense), net (2) (6,600) 1,000 (5,600) (7,000) (500) (7,500) Other non-operating income (expenses), net (2) (5) 1,000 -- 1,000 (100) -- (100) ---------- ---------- --------- ----------- --------- --------- Pre-tax income (loss) $ 3,600 $ 8,200 $ 11,800 $ (26,300) $ 6,000 $ (20,300) ========== ========== ========= =========== ========= ========= For the Six Month Period Ended June 30, 2005 2004 ------------------------------------- --------------------------------- Network Vyvx Total Network Vyvx Total ------- ----------- ---------- ------------- ---------- ------- (In thousands) Operating revenues (1) (3) $ 814,000 $ 59,200 $ 873,200 $ 717,200 $ 59,200 $ 776,400 ========== ========== ========= =========== ========= ========= Segment profit from operations (3) $ 98,100 $ 15,300 $ 113,400 $ 46,400 $ 15,100 $ 61,500 Depreciation and amortization expense (81,200) (2,200) (83,400) (105,700) (4,500) (110,200) Interest income (expense), net (2) (4) (11,900) 2,200 (9,700) (13,600) (1,100) (14,700) Other non-operating income (expenses), net (2) (5) 800 -- 800 2,900 -- 2,900 ---------- ---------- --------- ----------- --------- --------- Pre-tax income (loss) $ 5,800 $ 15,300 $ 21,100 $ (70,000) $ 9,500 $ (60,500) ========== ========== ========= =========== ========= ========= </TABLE> (1) Excludes intersegment revenues from amounts billed by Network to Vyvx of $4,400,000 and $4,600,000, respectively, for the three month periods ended June 30, 2005 and 2004, and $8,600,000 and $9,100,000, respectively, for the six month periods ended June 30, 2005 and 2004, and intersegment revenue billed from Network to ATX of $500,000 for the 2005 periods. (2) If items in these categories cannot be directly attributable to a particular WilTel segment, they are allocated to each segment based upon a formula that considers each segment's revenues, property and equipment and headcount. (3) For Network, for the three and six month periods ended June 30, 2005, includes $7,900,000 from the termination of a dark fiber contract and related maintenance services for which Network will not have to perform any remaining services and for which it has been paid; for the six month period ended June 30, 2005, includes gains of $13,000,000 from sales of operating assets, principally undersea cable assets. (4) For Vyvx for the six month period ended June 30, 2005, includes a bankruptcy claim distribution of $1,600,000 received for a security with no book value. (5) For the three and six month periods ended June 30, 2005, includes $1,100,000 related to the new agreements with SBC, which is discussed below. For the six month period ended June 30, 2004, WilTel's other non-operating income includes a pre-tax gain of $2,800,000 related to cash and securities received in excess of the book value of secured claims in a customer's bankruptcy. 23
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Interim Operations, continued. Network's revenues include services provided to SBC of $281,600,000 and $261,600,000 for the three month periods ended June 30, 2005 and 2004, respectively, representing approximately 70% and 71%, respectively, of Network's telecommunications revenues, and $560,700,000 and $500,000,000 for the six month periods ended June 30, 2005 and 2004, respectively, representing approximately 70% and 69%, respectively, of Network's telecommunications revenues. Network's revenues from SBC have continued to grow, principally related to voice products. Revenues attributable to other RBOCs were approximately 5% and 4% of Network's telecommunications revenues for the three month periods ended June 30, 2005 and 2004, respectively, and 6% and 5% for the six month periods ended June 30, 2005 and 2004, respectively. Revenues for non-SBC related business for the three and six month periods ended June 30, 2005 grew approximately 13% and 5%, respectively, over the same periods in 2004, principally from data products. Under the new SBC Master Services Agreement, SBC agreed to purchase WilTel services at the fixed prices that had been in effect on June 15, 2005, with minimum purchase commitments for on-net services of $600,000,000 for the period from January 1, 2005 through December 31, 2007, and $75,000,000 for the period from January 1, 2008 through December 31, 2009. If SBC fails to spend the required $600,000,000 or $75,000,000 during the respective designated periods, SBC will pay the amount of any deficiency and receive a credit equal to such amount to be used for future services. If SBC spends more than $600,000,000 during the initial three-year period, any excess will be credited toward the $75,000,000 commitment in the second period. SBC's minimum purchase commitments exclude access and off-net costs. However, for financial reporting purposes these costs are included as revenues, with offsetting amounts reported in telecommunications cost of sales, on the Company's consolidated statements of operations. As of June 30, 2005, approximately $120,000,000 of the minimum purchase commitments have been satisfied. Minimum purchase commitments are considered satisfied only when SBC has paid for the service provided, not when the service is recognized as revenue for financial reporting purposes. WilTel also has the opportunity to earn up to an additional $50,000,000 by meeting quality of service performance criteria in 2006 and 2007. The $236,000,000 of termination payments due from SBC (along with $7,000,000 previously funded by SBC for capital expenditures) is being classified as other non-operating Network income, which is not a component of segment profit from operations. It is being recognized as other income over time proportionally with the ratio of the minimum purchase commitments that have been earned subsequent to entering into the agreements with SBC, to the remaining minimum purchase commitment at June 15, 2005. For the periods ended June 30, 2005, $1,100,000 of this amount was reflected in other income. Network's cost of sales reflects the level of revenues, and is comprised of variable charges paid to access vendors to originate and/or terminate switched voice traffic, and fixed charges for leased facilities and local off-net costs. Network's cost of sales for the three and six month periods ended June 30, 2005 includes charges of approximately $1,300,000 and $3,900,000 for changes in the estimated accrual for access costs incurred but not yet billed. Adjustments to the estimated accrual for access costs for the same periods of 2004 were not material. In addition, access cost dispute resolutions were less favorable for the three and six month periods ended June 30, 2005 as compared to the prior year's periods by approximately $3,300,000 and $1,600,000, respectively. Network's cost of sales for the six months ended June 30, 2004 also included a charge of $3,500,000 for international voice access costs, for which no revenue was recognized. WilTel entered into a commitment for these access costs in order to provide services for a specific customer; however, the customer defaulted under its contract, and WilTel accrued the remaining amount of the commitment, but does not expect to be able to recover from its customer. Network's salaries and incentive compensation were $30,000,000 and $29,000,000 for the three month periods ended June 30, 2005 and 2004, respectively, and $58,800,000 and $56,600,000 for the six month periods ended June 30, 2005 and 2004, respectively, and selling, general and other expenses were $37,900,000 and $32,200,000 for the three month periods ended June 30, 2005 and 2004, respectively, and $78,300,000 and $70,500,000 for the 24
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Interim Operations, continued. six month periods ended June 30, 2005 and 2004, respectively. Selling, general and other expenses for the three and six month periods ended June 30, 2005 included greater contract maintenance costs primarily for equipment that is no longer under warranty ($3,000,000 and $3,200,000, respectively), higher sales commissions ($700,000 and $1,400,000, respectively) and the amortization of costs relating to WilTel's 2004 debt refinancing ($500,000 and $1,000,000, respectively). Selling, general and other expenses for the three and six month 2005 periods also reflect lower property and ad valorem taxes of $1,200,000 and $2,300,000, respectively. Selling, general and other expenses for the six month period ended June 30, 2005 also included a charge of $1,700,000 for repairs resulting from weather related fiber damage and increased advertising and legal expenses. For the three and six month periods ended June 30, 2004, selling, general and other expenses includes a reduction of $4,100,000 and $4,700,000, respectively, to the provision for doubtful accounts, principally due to the collection of previously reserved accounts receivable that had been in dispute. Selling, general and other expenses for the first quarter of 2004 included a charge of $2,700,000 to the provision for doubtful accounts to fully reserve for a customer's accounts receivable. Vyvx operating revenues were $30,400,000 and $31,400,000 for the three month periods ended June 30, 2005 and 2004, respectively, and $59,200,000 for each of the six month periods ended June 30, 2005 and 2004. The slight decline in revenues in the second quarter of 2005 as compared to 2004 reflects the impact of price reductions and the loss of the National Hockey League revenues resulting from its labor dispute, partially offset by higher occasional fiber business. Revenues for the six month period ended June 30, 2005 were largely unchanged compared to the same period in 2004 due to increased advertising distribution services relating to movies, partially offset by the impact of the factors mentioned above for the three month periods. Vyvx cost of sales reflects the level of revenue and is comprised primarily of amounts billed by Network to Vyvx for transporting content over the WilTel network, costs paid to other providers for local access and other off-net services, transponder expenses and freight and overnight delivery costs. The Company's consolidated statement of operations includes Vyvx salaries and incentive compensation expense of $4,600,000 for each of the three month periods ended June 30, 2005 and 2004 and $9,100,000 and $8,800,000 for the six month periods ended June 30, 2005 and 2004, respectively, and selling, general and other expenses of $4,100,000 and $3,600,000 for the three month periods ended June 30, 2005 and 2004, respectively, and $7,900,000 and $7,200,000 for the six month periods ended June 30, 2005 and 2004, respectively. Vyvx's gross margins remained relatively unchanged in the second quarter of 2005 as compared to the same period in 2004 as costs decreased consistent with the decline in revenues. The increase in Vyvx's gross margins for the six month 2005 period compared to the same period in 2004 resulted primarily from higher advertising distribution services revenue and a greater percentage of those services being provided by electronic versus physical distribution, for which the costs are lower. Depreciation and amortization expense for the Network and Vyvx segments declined in the 2005 periods as compared to the 2004 periods, principally as a result of certain assets becoming fully depreciated partially offset by the impact of new depreciable assets being placed into service. Telecommunications - ATX ATX has been consolidated by the Company since April 22, 2005, the effective date of its bankruptcy plan. For the 2005 periods, ATX telecommunications revenues and other income were $30,700,000, telecommunications cost of sales were $19,400,000, salaries and incentive compensation expense was $5,100,000, depreciation and amortizations expenses were $1,800,000, selling, general and other expenses were $5,000,000 and ATX had a pre-tax loss of $700,000. ATX results reflect intersegment charges from WilTel's Network segment of $500,000. 25
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Interim Operations, continued. Healthcare Services Pre-tax income of the healthcare services segment was $800,000 and $5,400,000 for the three month periods ended June 30, 2005 and 2004, respectively, and $2,200,000 and $7,800,000 for the six month periods ended June 30, 2005 and 2004, respectively. For the three month periods ended June 30, 2005 and 2004, healthcare services revenues were $61,100,000 and $64,100,000, respectively, and cost of sales, which primarily consist of salaries and employee benefits, was $51,300,000 and $52,300,000, respectively. For the six month periods ended June 30, 2005 and 2004, healthcare services revenues were $129,000,000 and $127,300,000, respectively, and cost of sales were $107,800,000 and $104,100,000, respectively. The decrease in healthcare revenues for the second quarter of 2005 as compared to the same period in 2004 principally resulted from its termination of certain underperforming customers, customer attrition and the sale of Symphony's respiratory line of business. The increase in healthcare revenues for the six month 2005 period as compared to the same period in 2004 primarily resulted from an increase in the amount of services provided and an increase in outpatient therapy rates. During the six month periods ended June 30, 2005 and 2004, one customer accounted for approximately 13% and 16%, respectively, of Symphony's revenues. The decline in gross margins in the 2005 periods as compared to the 2004 periods reflects revenue changes discussed above, higher hourly wages and benefits paid to attract and retain therapists and greater amounts incurred for independent contractors, both due to a shortage of licensed therapists in the marketplace. The decline in pre-tax results for the 2005 periods also reflects higher borrowing costs, depreciation expense, professional fees for certain outsourced services and expenditures for hiring, training and automation, which Symphony hopes will help offset the increase in the costs of therapists. Pre-tax results for the six month period ended June 30, 2005 period also reflect aggregate gains of $500,000 from the sale of certain property and the respiratory line of business. Pre-tax income for the 2004 periods also included $2,700,000 from the collection of receivables in excess of their carrying amounts. Manufacturing Pre-tax income for the plastics manufacturing segment was $4,700,000 and $2,300,000 for the three month periods ended June 30, 2005 and 2004, respectively, and $7,900,000 and $3,300,000 for the six month periods ended June 30, 2005 and 2004, respectively. Its revenues were $24,600,000 and $16,700,000 for the three month periods ended June 30, 2005 and 2004, respectively, and $45,400,000 and $30,100,000 for the six month periods ended June 30, 2005 and 2004, respectively. Revenues for the plastics manufacturing segment increased by $7,900,000 and $15,300,000 in the three and six month periods ended June 30, 2005 as compared to the same periods in 2004, reflecting NSW's revenues since acquisition of $5,100,000 and $7,500,000, respectively, and increases in substantially all of the segment's markets. These increases result from a variety of factors including strong housing and construction markets, new products developed late in 2004, and the impact of price increases implemented during the second half of 2004 and in the first quarter of 2005. Although raw material costs increased significantly in 2005, the aforementioned increases in selling prices in most markets, along with increased sales and production volumes enabled this segment to maintain its gross profit margins. Gross margins for the three and six month periods ended June 30, 2005 also reflect $200,000 and $500,000, respectively, of greater amortization expense on intangible assets resulting from acquisitions. Revenues for ITC from the date of acquisition through June 30, 2005 were $63,500,000; gross profit was $3,400,000, depreciation and amortization expenses were $1,800,000 and pre-tax loss was $400,000. ITC revenues, gross profit and pre-tax results reflect an oversupply in its dimensional lumber and home center boards markets, which has resulted in lower sales prices without a corresponding reduction in raw material costs. 26
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Interim Operations, continued. Banking and Lending As stated in the 2004 10-K, the current activities of the banking and lending segment are concentrated on collecting and servicing its remaining loan portfolio, maximizing returns on its investment portfolio and discharging deposit liabilities as they come due. As a result, revenues and expenses for this segment are reflective of the continuing decrease in the size of the loan portfolio, particularly as a result of the loan portfolios sales during 2004. Finance revenues, which reflect both the level and mix of consumer instalment loans, and pre-tax results decreased in the three and six month periods ended June 30, 2005 as compared to the similar periods in 2004, as average loans outstanding were $3,600,000 and $30,900,000 during the three month periods ended June 30, 2005 and 2004, respectively, and $3,800,000 and $109,500,000 for the six month periods ended June 30, 2005 and 2004, respectively. Pre-tax income for the banking and lending segment was $700,000 for the 2005 periods and $9,300,000 and $14,600,000 for the three and six month periods ended June 30, 2004, respectively. Pre-tax income for the 2004 periods includes a pre-tax gain of $9,000,000 on the sale of its subprime automobile and collateralized consumer loan portfolios. Domestic Real Estate Pre-tax income for the domestic real estate segment was $1,100,000 and $1,200,000 for the three month periods ended June 30, 2005 and 2004, respectively, and $500,000 and $9,100,000 for the six month periods ended June 30, 2005 and 2004, respectively. During the three and six month periods ended June 30, 2005, the Company recognized $1,600,000 and $2,500,000, respectively, of previously deferred pre-tax profit related to its 95-lot development project in South Walton County, Florida, upon completion of certain required improvements to the property. The Company expects to recognize the balance of the deferred pre-tax profits during 2005 (aggregating $7,600,000) from this project as it completes the remaining improvements. Revenues and pre-tax profit for this segment in the six month period ended June 30, 2004 reflected the sale of certain unimproved land for cash proceeds of $8,800,000, which resulted in a pre-tax gain of $7,600,000. In May 2005, the Company sold its 716-room Waikiki Beach hotel and related assets for an aggregate purchase price of $107,000,000, before closing costs and other required payments. The Company recorded a pre-tax gain of $56,600,000 in the second quarter of 2005, which is reflected in discontinued operations. Historical operating results for the hotel have not been material. Corporate and Other Operations Investment and other income increased in the three and six month periods ended June 30, 2005 as compared to the same periods in 2004 primarily due to greater interest income of $5,400,000 and $12,300,000, respectively, reflecting a larger amount of invested assets and higher interest rates. Investment and other income for the three and six month 2005 periods also reflect charges of $1,300,000 and $200,000, respectively, related to the accounting for mark-to-market values of Corporate derivatives as compared to income of $2,500,000 and $1,300,000, respectively, for the comparable 2004 periods. Net securities gains for Corporate and Other Operations aggregated $46,900,000 and $52,300,000 for the three month periods ended June 30, 2005 and 2004, respectively, and $47,000,000 and $61,600,000 for the six month periods ended June 30, 2005 and 2004, respectively. Net securities gains for the three and six month periods ended June 30, 2005 include a provision of $1,000,000 and $3,300,000, respectively, to write down the Company's investments in certain available for sale securities. Write downs of securities were $600,000 for the 2004 periods. The increase in interest expense during the three and six month periods ended June 30, 2005 as compared to the 2004 periods primarily reflects interest expense relating to $100,000,000 aggregate principal amount of 7% Senior Notes and $350,000,000 principal amount of its 3 3/4% Convertible Senior Subordinated Notes issued in April 2004. 27
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Interim Operations, continued. The increase in salaries and incentive compensation expense of $2,300,000 and $3,200,000, respectively, in the three and six month periods ended June 30, 2005 compared to the same periods in 2004, principally relates to increased bonus expense. The increase in selling, general and other expenses of $4,500,000 and $8,500,000, respectively, in the three and six month periods ended June 30, 2005 as compared to the same periods in 2004 primarily reflects greater cost of goods sold of the winery operations, higher professional fees that principally relate to due diligence expenses for potential investments, greater professional fees and greater foreign exchange losses. In addition, selling, general and other expenses for the three and six month 2005 periods also include $1,300,000 and $2,100,000, respectively, related to Indular, an Argentine shoe manufacturing company acquired in January 2005 in which the Company has an effective 59% interest. As discussed above, the income tax provision for the 2005 periods reflect a credit of $1,110,000,000 as a result of the reversal of a portion of the valuation allowance for the deferred tax asset. The Company adjusted the valuation allowance since it believes it is more likely than not that it will have future taxable income sufficient to realize that portion of the net deferred tax asset. For the periods ended June 30, 2004, the Company has recorded a net federal income tax provision on income from continuing operations, inclusive of a federal tax provision netted against equity in income of associated companies. The provision for federal income tax on income from continuing operations is fully offset by federal income tax benefits recognized on losses in other comprehensive income and losses from discontinued operations. As a result, when all components of income are aggregated there is no net federal income tax expense recorded for the periods ended June 30, 2004. Income taxes for the 2004 periods also include a provision for state income taxes. Associated Companies Equity in income (losses) of associated companies for the three and six month periods ended June 30, 2005 and 2004 includes the following (in thousands): <TABLE> <CAPTION> For the Three Month For the Six Month Period Ended June 30, Period Ended June 30, ------------------------- -------------------------- 2005 2004 2005 2004 ------- -------- -------- ------ <S> <C> <C> <C> <C> Olympus Re Holdings, Ltd. $ 4,900 $ 7,200 $ 12,000 $ 15,500 EagleRock Capital Partners (QP), LP (14,700) 1,600 (19,500) 5,900 Jefferies Partners Opportunity Fund II, LLC 4,700 4,300 11,100 8,700 HomeFed Corporation 500 1,700 500 3,700 Union Square 72,000 500 72,300 700 Pershing -- 3,100 -- 6,000 Berkadia -- -- -- 800 Other 600 900 2,800 2,000 -------- -------- -------- -------- Pre-tax 68,000 19,300 79,200 43,300 Income tax expense 700 15,200 700 15,200 -------- -------- -------- -------- Equity in income, net of taxes $ 67,300 $ 4,100 $ 78,500 $ 28,100 ======== ======== ======== ======== </TABLE> As discussed above, the Company redeemed its interest in Pershing effective December 31, 2004. In May 2005, Union Square sold its interest in an office complex located on Capitol Hill in Washington, D.C. During the second quarter, the Company received its share of the net proceeds totaling $71,800,000 and expects to receive in the fourth quarter an additional $1,000,000 for its share of escrowed proceeds. The Company recognized a pre-tax gain on the sale, including the escrowed proceeds, of $71,900,000. 28
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Interim Operations, continued. Cautionary Statement for Forward-Looking Information Statements included in this Management's Discussion and Analysis of Financial Condition and Results of Interim Operations may contain forward-looking statements. Such statements may relate, but are not limited, to projections of revenues, income or loss, capital expenditures, plans for growth and future operations, competition and regulation, as well as assumptions relating to the foregoing. Such forward-looking statements are made pursuant to the safe-harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are inherently subject to risks and uncertainties, many of which cannot be predicted or quantified. When used in this Management's Discussion and Analysis of Financial Condition and Results of Interim Operations, the words "estimates", "expects", "anticipates", "believes", "plans", "intends" and variations of such words and similar expressions are intended to identify forward-looking statements that involve risks and uncertainties. Future events and actual results could differ materially from those set forth in, contemplated by or underlying the forward-looking statements. The factors that could cause actual results to differ materially from those suggested by any of these statements or which may materially and adversely affect the Company's actual results include, but are not limited to, those discussed or identified from time to time in the Company's public filings, including: A worsening of general economic and market conditions or increases in prevailing interest rate levels, which may result in reduced sales of our products and services, lower valuations for our associated companies and investments or a negative impact on the credit quality of our assets; Changes in foreign and domestic laws, regulations and taxes, which may result in higher costs and lower revenue for our businesses, including as a result of unfavorable political and diplomatic developments, currency fluctuations, changes in governmental policies, expropriation, nationalization, confiscation of assets and changes in legislation relating to non-U.S. ownership; Increased competition and changes in pricing environments, which may result in decreasing revenues and/or margins, increased raw materials costs for our plastics manufacturing business and ITC, loss of market share or significant price erosion; Continued instability and uncertainty in the telecommunications industry, associated with increased competition, aggressive pricing and overcapacity; Dependence on key personnel, in particular, our Chairman and President, the loss of whom would severely affect our ability to develop and implement our business strategy; Inability to attract and retain highly skilled personnel, which would make it difficult to conduct the businesses of certain of our subsidiaries, including WilTel and Symphony; Adverse legal and regulatory developments that may affect particular businesses, such as regulatory developments in the telecommunications and healthcare industries, or in the environmental area, which could affect the Company's real estate development activities and telecommunications business, as well as the Company's other operations; The extent to which WilTel is successful in replacing revenues and profits generated by SBC upon the migration of services from WilTel to AT&T, which, if not successful will have a significant unfavorable impact on WilTel's results of operations; WilTel's ability to acquire or maintain rights of way necessary for the operation of its network, which could require WilTel to find alternate routes or increase WilTel's costs to provide services to its customers; 29
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Interim Operations, continued. WilTel's dependence on a small number of suppliers and high-volume customers, the loss of any of which could adversely affect WilTel's ability to generate operating profits and positive cash flows; Changes in telecommunications laws and regulations, which could adversely affect WilTel and its customers through, for example, higher costs, increased competition and a loss of revenue; Adverse regulatory developments impacting Medicare, which could materially reduce Symphony's revenues; The ability of the Company to generate sufficient taxable income in the future to realize its net deferred tax asset, which if not achieved could result in the need to record an income tax provision to increase the valuation allowance for the deferred tax asset; Weather related conditions and significant natural disasters, including hurricanes, tornadoes, windstorms, earthquakes and hailstorms, which may impact our wineries, real estate holdings and reinsurance operations; The inability to insure or reinsure certain risks economically, or the ability to collect on insurance or reinsurance policies, which could result in the Company having to self-insure business risks; Changes in U.S. real estate markets and real estate collateral values, including the residential market in Southern California and the commercial market in Washington, D.C., which are sensitive to mortgage interest rate levels; Adverse economic, political or environmental developments in Spain, which could delay or preclude the issuance of permits necessary to develop the Las Cruces copper mining project or which could result in increased costs of bringing the project to completion and increased costs in financing the development of the project; The inability to obtain necessary financing for the Las Cruces copper mining project, or the failure of the Inmet transaction to close, which could delay or prevent completion of the project; Decreases in world wide copper prices or weakening of the U.S. dollar against the euro, which could adversely affect the commercial viability of the Las Cruces copper mining project; WilTel's ability to adapt to technological developments or continued or increased pricing competition in the telecommunications industry, which could adversely affect WilTel's ability to generate operating profits and positive cash flows; WilTel's inability to generate operating profits and positive cash flows, which could result in a default under WilTel's credit agreement, pursuant to which substantially all of its assets are pledged; Current and future legal and administrative claims and proceedings against WilTel, which may result in increased costs and diversion of management's attention; Regional or general increases in the cost of living, particularly in the regions in which the Company has operations or sells its products or services, which may result in lower sales of such products and services; and 30
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Interim Operations, continued. Risks associated with future acquisitions and investments, including changes in the composition of the Company's assets and liabilities through such acquisitions, competition from others for potential acquisition targets, diversion of management's attention from normal daily operations of the business and insufficient revenues to offset increased expenses associated with acquisitions. This list of factors that may affect future performance and the accuracy of forward-looking statements is illustrative, but is not intended to be exhaustive. Therefore, all forward-looking statements should be evaluated with the understanding of their inherent uncertainty. Undue reliance should not be placed on these forward-looking statements, which are applicable only as of the date hereof. The Company undertakes no obligation to revise or update these forward-looking statements to reflect events or circumstances that arise after the date of this Management's Discussion and Analysis of Financial Condition and Results of Interim Operations or to reflect the occurrence of unanticipated events. Item 3. Quantitative and Qualitative Disclosures About Market Risk. Information required under this Item is contained in Item 7A of the Company's Annual Report on Form 10-K for the year ended December 31, 2004, and is incorporated by reference herein. Item 4. Controls and Procedures. Evaluation of disclosure controls and procedures (a) The Company's management evaluated, with the participation of the Company's principal executive and principal financial officers, the effectiveness of the Company's disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act")), as of June 30, 2005. Based on their evaluation, the Company's principal executive and principal financial officers concluded that the Company's disclosure controls and procedures were effective as of June 30, 2005. Changes in internal control over financial reporting (b) As discussed elsewhere herein, during the second quarter of 2005 the Company acquired ATX and ITC. Each of ATX and ITC have their own distinct internal controls over financial reporting; therefore, such internal controls represent a new component part of the Company's consolidated internal control over financial reporting. The Company has not yet completed its evaluation of the internal controls over financial reporting at ATX or ITC, although these entities have or are expected to have financial statement amounts which are material to the Company's consolidated financial statements. Except for changes that result from the acquisition of ATX and ITC, there have been no changes in the Company's internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the Company's fiscal quarter ended June 30, 2005, that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting. 31
PART II - OTHER INFORMATION Item 4. Submission of Matters to a Vote of Security Holders. The following matters were submitted to a vote of shareholders at the Company's 2005 Annual Meeting of Shareholders held on May 17, 2005. a) Election of directors. <TABLE> <CAPTION> Number of Shares ---------------- For Withheld --- -------- <S> <C> <C> Ian M. Cumming 95,944,036 1,263,019 Paul M. Dougan 95,564,476 1,642,579 Lawrence D. Glaubinger 95,558,353 1,648,702 Alan J. Hirschfield 88,708,800 8,498,255 James E. Jordan 88,400,987 8,806,068 Jeffrey C. Keil 96,233,858 973,197 Jesse Clyde Nichols, III 95,569,675 1,637,380 Joseph S. Steinberg 95,899,548 1,307,507 </TABLE> b) Approval of an amendment to the Company's certificate of incorporation to increase the number of common shares, par value $1.00 per share, authorized for issuance to 300,000,000 common shares. For 94,176,729 Against 2,971,875 Abstentions 56,849 Broker non-votes 1,602 c) Approval of an amendment to the Company's 2003 Senior Executive Annual Incentive Bonus Plan extending the plan through fiscal year 2014, so that the plan, as revised, will be in effect for the duration of the new employment agreements entered into with Ian M. Cumming and Joseph S. Steinberg, which expire June 15, 2015. For 85,895,060 Against 10,592,782 Abstentions 717,608 Broker non-votes 1,605 d) Ratification of PricewaterhouseCoopers LLP, as independent auditors for the year ended December 31, 2005. For 96,825,336 Against 310,686 Abstentions 69,431 Broker non-votes 1,602 32
Item 6. Exhibits. 10.1 Letter Agreement, dated May 25, 2005, between SBC Communications, Inc. and WilTel Communications Group, Inc. 31.1 Certification of Chairman of the Board and Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.2 Certification of President pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.3 Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.1 Certification of Chairman of the Board and Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.2 Certification of President pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.3 Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 33
SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. LEUCADIA NATIONAL CORPORATION (Registrant) Date: August 8, 2005 By: /s/ Barbara L. Lowenthal ------------------------------- Barbara L. Lowenthal Vice President and Comptroller (Chief Accounting Officer) 34
Exhibit Index 10.1 Letter Agreement, dated May 25, 2005, between SBC Communications, Inc. and WilTel Communications Group, Inc. 31.1 Certification of Chairman of the Board and Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.2 Certification of President pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.3 Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.1 Certification of Chairman of the Board and Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.2 Certification of President pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.3 Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 35