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, 2004 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 30, 2004: 70,900,502.
PART I - FINANCIAL INFORMATION Item 1. Financial Statements. LEUCADIA NATIONAL CORPORATION AND SUBSIDIARIES Consolidated Balance Sheets June 30, 2004 and December 31, 2003 (Dollars in thousands, except par value) <TABLE> <CAPTION> June 30, December 31, 2004 2003 ----------- ----------- (Unaudited) <S> <C> <C> ASSETS Current assets: Cash and cash equivalents $ 563,021 $ 214,390 Investments 910,823 714,363 Trade, notes and other receivables, net 331,803 372,104 Prepaids and other current assets 51,301 49,506 ----------- ----------- Total current assets 1,856,948 1,350,363 Non-current investments 729,776 673,742 Notes and other receivables, net 18,180 193,459 Other assets 247,946 223,970 Property, equipment and leasehold improvements, net 1,423,714 1,524,718 Investments in associated companies 492,130 430,912 ----------- ----------- Total $ 4,768,694 $ 4,397,164 =========== =========== LIABILITIES Current liabilities: Trade payables and expense accruals $ 377,851 $ 377,473 Deferred revenue 43,945 47,311 Other current liabilities 103,087 89,390 Customer banking deposits due within one year 50,784 103,331 Long-term debt due within one year 50,614 23,956 Income taxes payable 18,821 15,867 ----------- ----------- Total current liabilities 645,102 657,328 Long-term deferred revenue 158,280 156,582 Other non-current liabilities 220,266 234,446 Non-current customer banking deposits 13,414 42,201 Long-term debt 1,579,941 1,154,878 ----------- ----------- Total liabilities 2,617,003 2,245,435 ----------- ----------- Commitments and contingencies Minority interest 16,555 17,568 ----------- ----------- Shareholders' Equity Common shares, par value $1 per share, authorized 150,000,000 shares; 70,896,002 and 70,823,502 shares issued and outstanding, after deducting 47,710,719 shares held in treasury 70,896 70,824 Additional paid-in capital 615,014 613,274 Accumulated other comprehensive income 129,391 152,251 Retained earnings 1,319,835 1,297,812 ----------- ----------- Total shareholders' equity 2,135,136 2,134,161 ----------- ----------- Total $ 4,768,694 $ 4,397,164 =========== =========== </TABLE> See notes to interim consolidated financial statements. 2
LEUCADIA NATIONAL CORPORATION AND SUBSIDIARIES Consolidated Statements of Operations For the periods ended June 30, 2004 and 2003 (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, --------------------- --------------------- 2004 2003 2004 2003 ---- ---- ---- ---- <S> <C> <C> <C> <C> Revenues: Telecommunications $ 395,414 $ -- $ 776,393 $ -- Healthcare 64,044 -- 127,271 -- Manufacturing 16,683 14,078 30,065 26,225 Finance 1,279 14,734 9,764 31,878 Investment and other income 41,526 40,609 77,956 65,912 Net securities gains (losses) 52,346 (2,091) 61,618 214 --------- -------- --------- --------- 571,292 67,330 1,083,067 124,229 --------- -------- --------- --------- Expenses: Cost of sales: Telecommunications 285,514 -- 572,291 -- Healthcare 52,281 -- 104,067 -- Manufacturing 11,831 10,201 21,527 19,150 Interest 24,743 7,473 45,746 14,272 Salaries 45,584 6,927 88,724 15,999 Depreciation and amortization 58,975 3,921 122,100 8,512 Selling, general and other expenses 68,485 27,139 140,393 58,828 --------- -------- --------- --------- 547,413 55,661 1,094,848 116,761 --------- -------- --------- --------- Income (loss) from continuing operations before income taxes, minority expense of trust preferred securities and equity in income (losses) of associated companies 23,879 11,669 (11,781) 7,468 Income tax provision (benefit) (3,889) 1,348 (3,616) (138) --------- -------- --------- --------- Income (loss) from continuing operations before minority expense of trust preferred securities and equity in income (losses) of associated companies 27,768 10,321 (8,165) 7,606 Minority expense of trust preferred securities, net of taxes -- (1,380) -- (2,761) Equity in income (losses) of associated companies, net of taxes 4,151 2,542 28,132 (7,148) --------- -------- --------- --------- Income (loss) from continuing operations 31,919 11,483 19,967 (2,303) Income from discontinued operations, net of tax benefit of $663 for 2003 2,056 3,934 2,056 3,934 --------- -------- --------- --------- Net income $ 33,975 $ 15,417 $ 22,023 $ 1,631 ========= ======== ========= ========= Basic earnings (loss) per common share: Income (loss) from continuing operations $ .45 $ .19 $ .28 $ (.04) Income from discontinued operations .03 07 .03 .07 --------- -------- --------- --------- Net income $ .48 $ .26 $ .31 $ .03 ========= ======== ========= ========= Diluted earnings (loss) per common share: Income (loss) from continuing operations $ .44 $ .19 $ .28 $ (.04) Income from discontinued operations .03 07 .03 .07 --------- -------- --------- --------- Net income $ .47 $ .26 $ .31 $ .03 ========= ======== ========= ========= </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, 2004 and 2003 (In thousands) (Unaudited) <TABLE> <CAPTION> 2004 2003 ---- ---- <S> <C> <C> Net cash flows from operating activities: Net income $ 22,023 $ 1,631 Adjustments to reconcile net income to net cash provided by (used for) operations: Deferred income tax provision (benefit) 10,752 (2,248) Depreciation and amortization of property, equipment and leasehold improvements 124,564 9,893 Other amortization 1,127 82 Provision for doubtful accounts (6,542) 5,357 Net securities gains (61,618) (214) Equity in (income) losses of associated companies (43,280) 7,148 Distributions from associated companies 20,948 22,129 Gain on disposal of real estate, property and equipment, loan receivables and other assets (16,197) (13,950) Gain on disposal of discontinued operations (2,056) -- Investments classified as trading, net 11,608 (9,446) Net change in: Trade, notes and other receivables 28,195 (5,113) Prepaids and other assets (14,091) (12,060) Trade payables and expense accruals 13,236 (12,885) Other liabilities 7,559 (2,006) Deferred revenue (1,668) -- Income taxes payable 2,954 1,734 Other (1,689) (337) Net change in net assets of discontinued operations -- (1,824) ----------- ---------- Net cash provided by (used for) operating activities 95,825 (12,109) ----------- ---------- Net cash flows from investing activities: Acquisition of property, equipment and leasehold improvements (48,074) (3,308) Acquisitions of and capital expenditures for real estate investments (5,193) (11,383) Proceeds from disposals of real estate, property and equipment, and other assets 25,467 13,829 Cash acquired upon acquisition of WebLink -- 21,459 Advances on loan receivables -- (2,966) Principal collections on loan receivables 37,280 73,674 Proceeds from sale of loan receivables 149,042 -- Advances on notes receivables (400) (400) Collections on notes receivables 26,868 13,214 Investments in associated companies (51,422) (11,390) Purchases of investments (other than short-term) (1,202,857) (520,385) Proceeds from maturities of investments 402,225 140,405 Proceeds from sales of investments 567,756 307,446 ----------- ---------- Net cash provided by (used for) investing activities (99,308) 20,195 ----------- ---------- Net cash flows from financing activities: Net change in customer banking deposits (81,002) (138,697) Issuance of long-term debt, net of issuance costs 437,598 211,049 Reduction of long-term debt (6,182) (2,548) Issuance of common shares 1,812 522 ----------- ---------- Net cash provided by financing activities 352,226 70,326 ----------- ---------- Effect of foreign exchange rate changes on cash (112) 302 ----------- ---------- Net increase in cash and cash equivalents 348,631 78,714 Cash and cash equivalents at January 1, 214,390 418,600 ----------- ---------- Cash and cash equivalents at June 30, $ 563,021 $ 497,314 =========== ========== </TABLE> See notes to interim consolidated financial statements. 4
LEUCADIA NATIONAL CORPORATION AND SUBSIDIARIES Consolidated Statements of Changes in Shareholders' Equity For the six months ended June 30, 2004 and 2003 (In thousands, except par value) (Unaudited) <TABLE> <CAPTION> Series A Non-Voting Common Accumulated Convertible Shares Additional Other Preferred $1 Par Paid-In Comprehensive Retained Stock Value Capital Income (Loss) Earnings Total ------------ ------- ---------- ------------- --------- ---------- <S> <C> <C> <C> <C> <C> <C> Balance, January 1, 2003 $47,507 $58,269 $154,260 $ 56,025 $1,218,464 $1,534,525 ---------- Comprehensive income: Net change in unrealized gain (loss) on investments, net of taxes of $24,541 45,435 45,435 Net change in unrealized foreign exchange gain (loss), net of taxes of $971 4,468 4,468 Net change in unrealized gain (loss) on derivative instruments, net of taxes of $399 (741) (741) Net income 1,631 1,631 ---------- Comprehensive income 50,793 ---------- Conversion of convertible preferred shares into common shares (47,507) 1,348 46,159 -- Exercise of options to purchase common shares 22 500 522 Purchase of stock for treasury (2) (59) (61) ------- ------- -------- -------- ---------- ---------- Balance, June 30, 2003 $ -- $59,637 $200,860 $105,187 $1,220,095 $1,585,779 ======= ======= ======== ======== ========== ========== Balance, January 1, 2004 $ -- $70,824 $613,274 $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 72 1,740 1,812 ------- ------- -------- -------- ---------- ---------- Balance, June 30, 2004 $ -- $70,896 $615,014 $129,391 $1,319,835 $2,135,136 ======= ======= ======== ======== ========== ========== </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, 2003, 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 "2003 10-K"). Results of operations for interim periods are not necessarily indicative of annual results of operations. The consolidated balance sheet at December 31, 2003 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. Certain amounts for prior periods have been reclassified to be consistent with the 2004 presentation. 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 net income would not have been materially different from that reported. In January 2003, the Financial Accounting Standards Board ("FASB") issued FASB Interpretation No. 46 ("FIN 46"), which addresses consolidation of variable interest entities, which are entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. In December 2003, the FASB issued a revision ("FIN 46R") to FIN 46 to clarify certain provisions and exempt certain entities from its requirements. In addition, FIN 46R deferred to the first quarter of 2004 application of its provisions to certain entities in which a variable interest was acquired prior to February 1, 2003. The implementation of FIN 46 and FIN 46R did not have a material effect on the Company's consolidated results of operations or financial condition. 2. Results of operations for the Company's segments are reflected from the date of acquisition. As more fully described in the 2003 10-K, WilTel Communications Group, Inc. ("WilTel") became a consolidated subsidiary of the Company in November 2003, and Symphony Health Services, LLC ("Symphony") became a consolidated subsidiary of the Company in September 2003. 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, minority expense of trust preferred securities 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 measure under GAAP, which is used for all other reportable segments, for the three and six month periods ended June 30, 2004 (in thousands): 6
Notes to Interim Consolidated Financial Statements, continued <TABLE> <CAPTION> For the Three Month For the Six Month Period Ended June 30, 2004 Period Ended June 30, 2004 -------------------------- -------------------------- Network Vyvx Network Vyvx ------- ---- ------- ---- <S> <C> <C> <C> <C> Segment profit from operations (1) $ 31,891 $ 8,713 $ 46,350 $ 15,064 Depreciation and amortization expense (51,117) (2,174) (105,662) (4,462) Interest expense, net of investment income (2) (7,047) (529) (13,602) (1,085) Other non-operating income (expense), net (2) (66) (6) 2,938 14 --------- --------- ---------- -------- Income (loss) from continuing operations before income taxes, minority expense of trust preferred securities and equity in income (losses) of associated companies $ (26,339) $ 6,004 $ (69,976) $ 9,531 ========= ========= ========== ======== </TABLE> (1) See note (d) to segment information below. (2) These items have been allocated to each segment based upon a formula that considers each segment's revenues, property and equipment and headcount. Certain information concerning the Company's segments for the three and six month periods ended June 30, 2004 and 2003 is presented in the following table. <TABLE> <CAPTION> For the Three Month For the Six Month Period Ended June 30, Period Ended June 30, --------------------- --------------------- 2004 2003 2004 2003 ---- ---- ---- ---- <S> <C> <C> <C> <C> Revenues (a): Network (b) $ 369,698 $ -- $ 731,873 $ -- Vyvx 31,421 -- 59,384 -- Healthcare Services 64,068 -- 127,315 -- Banking and Lending 11,183 16,720 19,890 37,188 Manufacturing 16,675 14,437 30,076 26,603 Domestic Real Estate 10,363 16,104 27,754 26,226 Other Operations 8,153 8,105 16,803 15,175 Corporate (c) 64,312 11,964 79,044 19,037 Intersegment elimination (d) (4,581) -- (9,072) -- --------- --------- ---------- ---------- Total consolidated revenues $ 571,292 $ 67,330 $1,083,067 $ 124,229 ========= ========= ========== ========== Income (loss) from continuing operations before income taxes, minority expense of trust preferred securities and equity in income (losses) of associated companies: Network (d) $ (26,339) $ -- $ (69,976) $ -- Vyvx (d) 6,004 -- 9,531 -- Healthcare Services 5,405 -- 7,788 -- Banking and Lending 9,252 7,080 14,566 11,920 Manufacturing 2,336 1,515 3,262 1,777 Domestic Real Estate (5,382) 7,158 2,578 8,690 Other Operations (1,440) (140) (1,818) (1,214) Corporate (c) 34,043 (3,944) 22,288 (13,705) --------- --------- ---------- ---------- Total consolidated income (loss) from continuing operations before income taxes, minority expense of trust preferred securities and equity in income (losses) of associated companies $ 23,879 $ 11,669 $ (11,781) $ 7,468 ========= ========= ========== ========== </TABLE> 7
Notes to Interim Consolidated Financial Statements, continued (a) Revenues 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 (losses) on the Company's consolidated statements of operations. (b) Includes services provided to SBC Communications Inc. ("SBC") of $261,600,000 and $500,000,000, respectively, for the three and six month periods ended June 30, 2004, pursuant to long-term preferred provider agreements as described in the 2003 10-K. (c) Includes net securities gains of $52,500,000 and $61,500,000, respectively, for the three and six month periods ended June 30, 2004. (d) Eliminates intersegment revenues billed from Network to Vyvx. However, the intersegment revenues are included in the calculation to determine the income (loss) from continuing operations for each of Network and Vyvx. 3. The following tables provide summarized data with respect to significant investments in associated companies accounted for under the equity method of accounting for the periods the investments were owned by the Company and, with respect to WilTel, for the period prior to it becoming a consolidated subsidiary of the Company. The information is provided for those investments (other than WilTel) 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, 2004 (in thousands). <TABLE> <CAPTION> June 30, 2003 ---------- <S> <C> <C> Investment in WilTel: Total revenues $ 611,500 Loss from continuing operations before extraordinary items (119,900) Net loss (119,900) The Company's equity in net loss (57,100) June 30, June 30, 2004 2003 --------- -------- Investment in Berkadia: Total revenues $ 2,400 $ 80,500 Income from continuing operations before extraordinary items 2,200 68,100 Net income 2,200 68,100 The Company's equity in net income 800 27,300 Investment in Olympus Re Holdings, Ltd.: Total revenues $ 244,400 $ 209,900 Income from continuing operations before extraordinary items 96,700 90,100 Net income 96,700 90,100 The Company's equity in net income 15,500 22,500 Investment in EagleRock Capital Partners (QP), LP: Total revenues $ 7,400 $ 16,500 Income from continuing operations before extraordinary items 6,900 14,500 Net income 6,900 14,500 The Company's equity in net income 5,900 14,300 Investment in Jefferies Partners Opportunity Fund II, LLC: Total revenues $ 13,900 $ 11,100 Income from continuing operations before extraordinary items 12,600 9,700 Net income 12,600 9,700 The Company's equity in net income 8,700 6,900 </TABLE> 8
Notes to Interim Consolidated Financial Statements, continued For the three and six month periods ended June 30, 2004 and 2003, the Company's equity in the income of Berkadia consists of the following (in thousands): <TABLE> <CAPTION> For the Three Month For the Six Month Period Ended June 30, Period Ended June 30, --------------------- --------------------- 2004 2003 2004 2003 ---- ---- ---- ---- <S> <C> <C> <C> <C> Net interest spread on the Berkadia loan - 10% of total $ -- $ 600 $ -- $ 1,500 Net interest savings -- 500 300 900 Amortization of Berkadia loan discount related to cash fees - 50% of total -- 1,300 200 9,700 Amortization of Berkadia loan discount related to FINOVA stock - 50% of total -- 2,100 300 15,200 ------ ------ ------- -------- Equity in income of associated companies - Berkadia $ -- $ 4,500 $ 800 $ 27,300 ====== ======= ======= ======== </TABLE> Since the Berkadia loan was fully repaid during the first quarter of 2004, the Company will no longer have any income related to the Berkadia loan in future periods. Equity in income of associated companies is net of income tax expense of $15,200,000 and $13,500,000 for the three month periods ended June 30, 2004 and 2003, respectively, and $15,200,000 and $27,200,000 for the six month periods ended June 30, 2004 and 2003, respectively. 4. A summary of investments at June 30, 2004 and December 31, 2003 is as follows (in thousands): <TABLE> <CAPTION> June 30, 2004 December 31, 2003 ----------------------------- ------------------------------ 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 $ 838,977 $ 838,809 $ 606,387 $ 623,570 Trading securities 55,901 65,084 74,923 86,392 Other investments, including accrued interest income 6,930 6,930 4,401 4,401 --------- ---------- --------- ---------- Total current investments $ 901,808 $ 910,823 $ 685,711 $ 714,363 ========= ========== ========= ========== Non-current Investments: Investments available for sale $ 492,449 $ 712,100 $ 420,947 $ 655,178 Other investments 17,676 17,676 18,564 18,564 --------- ---------- --------- ---------- Total non-current investments $ 510,125 $ 729,776 $ 439,511 $ 673,742 ========= ========== ========= ========== </TABLE> 5. A summary of intangible assets (which are included in other assets in the consolidated balance sheets) at June 30, 2004 and December 31, 2003 is as follows (in thousands): <TABLE> <CAPTION> June 30, December 31, 2004 2003 ---------- ----------- <S> <C> <C> Tradename, net of accumulated amortization of $260 and $85 $ 4,961 $ 3,427 Customer relationships, net of accumulated amortization of $1,229 and $351 20,029 12,459 -------- ------- $ 24,990 $15,886 ======== ======= </TABLE> 9
Notes to Interim Consolidated Financial Statements, continued As more fully described in the 2003 10-K, tradename and customer relationship intangible assets were recognized in connection with the acquisition of WilTel. The net carrying amount of these intangible assets increased $8,200,000 during the first six months of 2004, due to the completion of certain, but not all of the analyses used to allocate the purchase price to the individual assets acquired, which also resulted in a reduction to the amount initially allocated to property and equipment. During 2004, the Company recorded $1,900,000 of customer relationship intangible assets in connection with an acquisition made by its manufacturing segment. The manufacturing segment's customer relationship intangible assets will be amortized on a straight-line basis over an average useful life of approximately three years. Amortization expense on intangible assets was $600,000 and $1,100,000, respectively, for the three and six month periods ended June 30, 2004. The estimated aggregate future amortization expense for the tradename and customer relationship intangible assets for each of the next five years is as follows (in thousands): 2004 (for the remaining six months) - $1,200; 2005 - $2,400; 2006 - $2,400; 2007 - $2,200; and 2008 - $1,800. As previously disclosed in the 2003 10-K, the Las Cruces mineral rights of MK Resources Company (formerly MK Gold Company) have been classified as an intangible asset. Effective April 2004, the FASB ratified the Emerging Issues Task Force's consensus that mineral rights should be accounted for as tangible assets and classified as a component of property and equipment. In accordance with this pronouncement, the Company has reclassified this asset in the consolidated balance sheet as of December 31, 2003. 6. Effective March 2004, the Company amended its unsecured bank credit facility to extend its maturity to March 2007. As of June 30, 2004, no amounts were outstanding under this $110,000,000 bank credit facility. 7. In April 2004, the Company sold $100,000,000 principal amount of its 7% Senior Notes due 2013 in a private placement transaction at 102.191% of the principal amount. The net cash proceeds from the sale of the notes are being used for general corporate purposes. The Company has completed a registered exchange offer pursuant to which each holder of the privately placed senior notes exchanged those notes for publicly registered notes. In April 2004, the Company sold $350,000,000 principal amount of its 3 3/4% Convertible Senior Subordinated Notes due 2014 (the "3 3/4% Convertible Notes") in a private placement transaction. The notes are convertible into the Company's common shares at $68.90 per share at any time before their maturity, subject to certain restrictions contained in the notes, at a conversion rate of 14.5138 shares per each $1,000 principal amount of notes (an aggregate of 5,079,830 shares), subject to adjustment. The net cash proceeds from the sale of the notes are being used for general corporate purposes. The Company is obligated to file a shelf registration statement in respect of the notes and the common shares issuable upon conversion of the notes. 8. A summary of accumulated other comprehensive income (loss) at June 30, 2004 and December 31, 2003 is as follows (in thousands): <TABLE> <CAPTION> June 30, December 31, 2004 2003 ---------- ---------- <S> <C> <C> Net unrealized gains on investments $ 139,367 $ 161,788 Net unrealized foreign exchange gains 6,430 7,502 Net unrealized losses on derivative instruments (2,767) (3,400) Net minimum pension liability (13,639) (13,639) ---------- --------- $ 129,391 $ 152,251 ========== ========= </TABLE> 9. Included in investment and other income is income of $2,500,000 and $1,300,000, respectively, for the three and six month periods ended June 30, 2004 and income (charges) of $(900,000) and $700,000, respectively, for the three and six month periods ended June 30, 2003, as a result of accounting for its derivative financial instruments in accordance with Statement of Financial Accounting Standards No. 133 ("SFAS 133"). 10
Notes to Interim Consolidated Financial Statements, continued 10. In May 2004, the Company sold its subprime automobile and collateralized consumer loan portfolios, which represented 97% of banking and lending's total outstanding loans (net of unearned finance charges) as of March 31, 2004. The Company received aggregate cash proceeds of $149,000,000 and reported a pre-tax gain of $9,000,000, which is reflected in investment and other income. The remaining activities at the banking and lending segment primarily consist of the collection or sale of its remaining loans (including pursuing recoveries for previously written-off loans) and the retirement or sale of its customer banking deposits using the segment's available cash. The Company expects to complete these activities during 2004, and upon completion will surrender its national bank charter. Once the liquidation of this segment is complete, it will be reclassified as a discontinued operation. 11. During the second quarter of 2004, selling, general and other expenses include a non-cash charge of approximately $7,100,000 to reduce the carrying amount of a commercial real estate property to its estimated fair value. The Company does not have an active program to dispose of the property and is not committed to do so; however, the Company is considering selling the property and has received a non-binding letter of intent from a third party purchaser. Accordingly, the Company has employed the held and used model to evaluate the recoverability of the property; fair value used to determine the impairment was estimated primarily based on the letter of intent. If the property is sold, the Company is likely to incur prepayment mortgage penalties of approximately $1,000,000, which have not been recorded at June 30, 2004. This property will be classified as a discontinued operation in the period in which it is either disposed of or meets the criteria for held for sale treatment. 12. Pension expense for the three and six month periods ended June 30, 2004 and 2003 related to the defined benefit pension plan (other than WilTel's plan) charged to operations included the following components (in thousands): <TABLE> <CAPTION> For the Three Month For the Six Month Period Ended June 30, Period Ended June 30, --------------------- --------------------- 2004 2003 2004 2003 ---- ---- ---- ---- <S> <C> <C> <C> <C> Interest cost $ 531 $ 581 $1,063 $1,162 Expected return on plan assets (447) (445) (895) (890) Actuarial loss 144 61 288 121 Amortization of prior service cost -- -- 1 1 ------ ------ ------ ------ Net pension expense $ 228 $ 197 $ 457 $ 394 ====== ====== ====== ====== </TABLE> WilTel's pension expense for the three and six month periods ended June 30, 2004 related to the defined benefit pension plan charged to operations included the following components (in thousands): <TABLE> <CAPTION> For the Three Month For the Six Month Period Ended June 30, 2004 Period Ended June 30, 2004 -------------------------- -------------------------- <S> <C> <C> Interest cost $ 1,612 $ 3,224 Service cost 864 1,727 Expected return on plan assets (961) (1,921) -------- --------- Net pension expense $ 1,515 $ 3,030 ======== ========= </TABLE> 11
Notes to Interim Consolidated Financial Statements, continued Employer contributions to WilTel's defined benefit pension plan were not material during the six month period ended June 30, 2004. As discussed in the 2003 10-K, 2004 pension contributions were expected to be $5,000,000; however, based on updated actuarial calculations, 2004 contributions are now expected to be $3,800,000. 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, 2004 and 2003. 13. In the fourth quarter of 2003, WebLink Wireless, Inc. sold substantially all of its operating assets to a subsidiary of Metrocall Holdings, Inc. ("Metrocall") and was classified as a discontinued operation. A portion of the sales proceeds consisted of a warrant to purchase up to 100,000 shares of Metrocall's common stock at $40 per share, subject to certain vesting criteria. During the second quarter of 2004, these warrants vested and the Company recorded $2,200,000 as gain on disposal of discontinued operations (net of minority interest), which represented the estimated fair value of the warrants. The gain has not been reduced for any federal income tax expense due to WebLink's large net operating loss carryforwards, which carried a full valuation allowance at December 31, 2003. During the second quarter of 2003, the Company settled certain tax payment responsibilities with the purchaser of Colonial Penn Insurance Company. Income from discontinued operations for the 2003 periods includes a payment of $1,800,000 from the purchaser to reimburse the Company for tax payments previously made. 14. For the six month period 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 a federal income tax benefit recognized on losses in other comprehensive income. 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. Income taxes for the 2003 periods differ from the expected statutory federal rate principally due to the exclusion of the income related to the refund of foreign taxes not based on income. 15. Per share amounts were calculated by dividing net 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 period 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 70,880,000 and 59,630,000 for the three month periods ended June 30, 2004 and 2003, respectively, and 70,863,000 and 59,624,000 for the six month periods ended June 30, 2004 and 2003, respectively. The number of shares used to calculate diluted earnings (loss) per share amounts was 75,299,000 and 60,069,000 for the three month periods ended June 30, 2004 and 2003, respectively, and 71,478,000 and 59,624,000 for the six month periods ended June 30, 2004 and 2003, respectively. For the six month period ended June 30, 2004, the 3 3/4% Convertible Notes were not included in the computation of diluted earnings per share, as these notes were antidilutive. For the six month period ended June 30, 2003, options and warrants to purchase approximately 407,000 weighted average shares of common stock were outstanding but were not included in the computation of diluted earnings (loss) per share, as those options and warrants were antidilutive. Due to the nature of their rights and their nominal liquidation value, the Series A Non-Voting Convertible Preferred Shares are treated as common shares and are included in the weighted average share calculations for basic and diluted per share computations for 2003. 16. On June 16, 2004, Joseph S. Steinberg, President of the Company, sold his warrants to purchase 400,000 of the Company's common shares to Jefferies & Company, Inc., based on a value of $50 per Leucadia share. The warrants are exercisable through May 15, 2005 at an exercise price of $23.95 per share. The Company has filed a shelf registration statement covering the 400,000 shares issuable upon conversion of the warrants. The registration statement has not been declared effective. 17. Cash paid for interest and net income taxes paid (refunded) was $38,000,000 and $(27,800,000), respectively, for the six month period ended June 30, 2004 and $14,200,000 and $3,300,000, respectively, for the six month period ended June 30, 2003. 12
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 2003 10-K. Liquidity and Capital Resources 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, as described below, 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. For the six month period ended June 30, 2003, net cash was used for operations principally as a result of an increase in the Company's investment in the trading portfolio, lower investment income on corporate investments and payment of corporate interest and overhead expenses. As of June 30, 2004, the Company's readily available cash, cash equivalents and marketable securities, excluding amounts held by its regulated subsidiaries and non-regulated subsidiaries that are parties to agreements which restrict the payment of dividends, totaled $1,644,800,000. This amount is comprised of cash and short-term bonds and notes of the United States Government and its agencies of $1,065,400,000 (65%), the equity investment in White Mountains Insurance Group, Ltd. of $191,300,000 (12%) (that 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 $388,100,000 (23%). In January 2004, the Company invested $50,000,000 for a limited partnership interest in Pershing Square, L.P. ("Pershing"), a partnership that is authorized to engage in a variety of investing activities. The Company has the right to receive an annual distribution equal to its share of Pershing's profits, if any, but cannot otherwise redeem its investment prior to December 31, 2005. Effective March 2004, the Company amended its unsecured bank credit facility to extend its maturity to March 2007. As of June 30, 2004, no amounts were outstanding under this $110,000,000 bank credit facility. In April 2004, the Company sold $100,000,000 principal amount of its 7% Senior Notes due 2013 in a private placement transaction at 102.191% of the principal amount. In April 2004, the Company sold $350,000,000 principal amount of its 3 3/4% Convertible Senior Subordinated Notes due 2014 in a private placement transaction. The net cash proceeds from the sales of the 7% Senior Notes and the 3 3/4% Convertible Senior Subordinated Notes are being used for general corporate purposes. As of June 30, 2004, WilTel had aggregate cash and investments of $246,700,000 (excluding investments pledged as collateral), an increase of $60,900,000 from December 31, 2003. During the six month period ended June 30, 2004, net cash was generated by WilTel's operating activities, and WilTel's capital expenditures were $38,900,000. In addition, in conjunction with a pricing agreement for certain voice services, WilTel received $25,000,000 from SBC for pre-funding of certain capital expenditures. If WilTel and SBC enter into another pricing agreement for certain voice services by January 2005, WilTel will be required to refund this amount to SBC. If WilTel and SBC do not enter into another pricing agreement by such date, to the extent the $25,000,000 is not spent as outlined in the agreement, the unspent portion is to be returned to SBC. The Company has reflected the amount received as a liability in its consolidated balance sheet. 13
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Interim Operations, continued. WilTel is a party to various legal actions and claims, and has reserved $38,900,000 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. On March 2, 2004, the U.S. Court of Appeals for the District of Columbia Circuit struck down a Federal Communications Commission ("FCC") rule that required regional telephone companies to open their networks to competitors at reasonable rates. Although a number of parties have petitioned for a Supreme Court review of this ruling, these petitions have not been granted. As a result, competing telephone companies may be charged higher rates by regional telephone companies to use parts of their networks, or incur costs to purchase and install their own networks in order to offer local phone service. This ruling is not expected to have a material impact on WilTel's costs but could have a significant impact on the costs of certain of WilTel's customers. In a May 2004 ruling, the FCC clarified that whenever traffic originates and terminates on the public switched telephone network, long distance carriers (such as WilTel) that carry such traffic must pay access charges. Regional Bell Operating Companies have attempted to recover unpaid access charges from long distance carriers who were following business practices not consistent with the FCC ruling. Although WilTel had been actively seeking clarification from the FCC concerning this matter, WilTel's policy has been to accrue access charges in a manner that it believes is consistent with the FCC's ruling. The FCC's ruling is not expected to have a material impact on WilTel; however, certain of WilTel's customers and competitors may be adversely affected. In July 2004, the Company filed a notification and report pursuant to the Hart-Scott-Rodino Antitrust Improvements Act of 1976 ("HSR") with the Federal Trade Commission and the Department of Justice with respect to acquiring 50% or more of the outstanding common stock of MCI Inc., a telecommunications company (formerly known as WorldCom Inc.). The waiting period under HSR is scheduled to expire on August 9, 2004, unless extended or earlier terminated. There can be no assurance that the Company will acquire control of MCI. As disclosed in the 2003 10-K, the Company had previously exercised an option to sell two of its older corporate aircraft for total proceeds of $38,800,000. The option was received in connection with the purchase of two new corporate aircraft. The Company completed the sales in July 2004, and expects to report a pre-tax gain of approximately $11,000,000 in the third quarter of 2004. As of December 31, 2003, Symphony was not in compliance with a financial covenant contained in its $50,000,000 credit facility but had obtained a waiver from the lender that suspended application of the covenant until March 31, 2004. Symphony is currently in compliance with the covenant and expects it will continue to be in compliance in the future. 14
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Interim Operations, continued. The Company's consolidated banking and lending operations had outstanding loans (net of unearned finance charges) of $6,200,000 and $205,500,000 at June 30, 2004 and December 31, 2003, respectively. These loans were primarily funded by deposits generated by the Company's deposit-taking facilities and by brokers, which totaled $64,200,000 and $145,500,000 at June 30, 2004 and December 31, 2003, respectively. The cash flows generated from the collections on and sales of its loan portfolios have been used to retire these deposits as they matured. During the second quarter of 2004, the Company sold its subprime automobile and collateralized consumer loan portfolios for aggregate cash proceeds of $149,000,000 and recognized a pre-tax gain of $9,000,000. The banking and lending segment is no longer making consumer loans; operating activities at this segment have been limited to maximizing the amount collected from its loan portfolios (including pursuing recoveries for previously written-off loans) and liquidating the business in an orderly and cost efficient manner. The Company expects to complete the liquidation of this segment during 2004, and will reclassify the segment as a discontinued operation at that time. Results of Operations The 2004 Periods Compared to the 2003 Periods Telecommunications The following table reconciles WilTel's segment profit from operations to pre-tax income (loss) for the three and six month periods ended June 30, 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 For the Six Month Period Ended June 30, 2004 Period Ended June 30, 2004 -------------------------- -------------------------- Network Vyvx Total Network Vyvx Total ------- ---- ----- ------- ---- ----- (In thousands) <S> <C> <C> <C> <C> <C> <C> Operating revenues (1) $ 364,100 $ 31,400 $ 395,500 $ 717,200 $59,200 $ 776,400 ========= ========= ========= ========= ======= ========= Segment profit from operations $ 31,900 $ 8,700 $ 40,600 $ 46,400 $15,100 $ 61,500 Depreciation and amortization expense (51,100) (2,200) (53,300) (105,700) (4,500) (110,200) Interest expense, net of investment income (2) (7,000) (500) (7,500) (13,600) (1,100) (14,700) Other non-operating income (expense), net (2) (100) -- (100) 2,900 -- 2,900 --------- --------- --------- --------- ------- --------- Pre-tax income (loss) $ (26,300) $ 6,000 $ (20,300) $ (70,000) $ 9,500 $ (60,500) ========= ========= ========= ========= ======= ========= </TABLE> (1) Excludes intersegment revenues from amounts billed by Network to Vyvx of $4,600,000 and $9,100,000, respectively, for the three and six month periods ended June 30, 2004. (2) These items have been allocated to each segment based upon a formula that considers each segment's revenues, property and equipment and headcount. 15
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Interim Operations, continued. As more fully discussed in the 2003 10-K, prior to November 2003 the Company accounted for its 47.4% share of WilTel's losses under the equity method of accounting, and recorded losses related to its investment in WilTel of $22,300,000 and $57,100,000, respectively, for the three and six month periods ended June 30, 2003. SBC, a major communications provider in the U.S., is WilTel's largest customer. As more fully described in the 2003 10-K, WilTel and SBC have entered into preferred provider agreements that extend until 2019, which govern the manner in which pricing for individual services is determined. Network's revenues include services provided to SBC of $261,600,000 and $500,000,000, respectively, during the three and six month periods ended June 30, 2004, representing approximately 71% and 68%, respectively of total Network revenues. Network's revenues from SBC have continued to grow, principally related to voice products, for which SBC and WilTel have agreed to use a fixed price through January 2005. The growth in voice revenue resulted from, in part, SBC's continued growth in long distance services in various states, including California, Michigan, Indiana, Ohio, Illinois and Wisconsin. Revenues and gross margins for non-SBC related business continue to reflect the excess telecommunications capacity in the marketplace, which has resulted in lower prices for WilTel and others in the industry, and created a very competitive environment for acquiring new business. Network cost of sales reflects the level of revenues, primarily due to traffic related access and egress costs. In addition, the first quarter of 2004 includes 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 which it does not expect to be able to recover from the customer. The Company's consolidated statement of operations includes salaries expense of $29,000,000 and $56,600,000, respectively, and selling, general and other expenses of $32,200,000 and $70,500,000, respectively, for Network during the three and six month periods ended June 30, 2004. For the three month period ended June 30, 2004, selling, general and other expenses includes a reduction of $4,100,000 to the provision for doubtful accounts, principally due to the collection of previously reserved accounts receivable which had been in dispute. During the first quarter of 2004, the provision for doubtful accounts included a charge of $2,700,000 to fully reserve for a customer's accounts receivable which is not expected to be collected. Network's segment profit from operations was $14,500,000 for the first quarter of 2004 as compared to $31,900,000 for the second quarter of 2004. The increase reflects the impact of SBC related non-recurring revenues and adjustments, the first quarter charge related to international voice access costs and the adjustments to the provision for bad debts discussed above. Other income for the six month period ended June 30, 2004 includes a gain of $2,800,000 related to cash and securities received in excess of the book value of a secured claim in a customer's bankruptcy. Vyvx revenues and profitability reflect the typical seasonality of the advertising distribution business, with lower volumes in the early part of the year as compared to higher volumes during the summer and holiday movie season. Cost of sales reflects the level of revenue. The Company's consolidated statement of operations includes salaries expense of $4,600,000 and $8,800,000, respectively, and selling, general and other expenses of $3,600,000 and $7,200,000, respectively, for Vyvx during the three and six month periods ended June 30, 2004. Healthcare Services For the three and six months period ended June 30, 2004, the pre-tax income of the healthcare services segment was $5,400,000 and $7,800,000, respectively. During these periods, healthcare services revenues were $64,000,000 and $127,300,000, respectively, and cost of sales, which primarily consist of salaries and employee benefits, were $52,300,000 and $104,100,000, respectively. Legislative caps on Part B Medicare therapy, which negatively impacted Symphony's revenues in 2003, have been removed for 2004 and 2005, and the fee schedule for such services has also been increased by 1.5%. As a result, Symphony's revenues for these therapy services increased approximately 40% in each of the first and second quarters of 2004 as compared to the fourth quarter 16
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Interim Operations, continued. of 2003, comparing only those locations that were operating during all periods. Symphony also added new customers during 2004; however, certain low margin and non-profitable accounts were cancelled resulting in a slight decrease in total locations serviced. During 2004, one customer accounted for approximately 16% of Symphony's revenues. The increase in pre-tax income during the second quarter of 2004 as compared to the first quarter principally results from the collection of receivables in excess of their carrying amounts by approximately $2,700,000. The ability of Symphony to continue to grow its business depends heavily upon its ability to attract, develop and retain qualified therapists. There is a current shortage of qualified therapists industry-wide, and Symphony has open positions for both full-time and part-time professionals. The inability to fully staff these positions in-house causes Symphony and others in its industry to hire independent contractors to perform required services, which increases costs, thereby reducing margins, and can also result in lost revenue opportunities. Banking and Lending As stated previously, the current activities of the banking and lending segment are limited to liquidating its business in an orderly and cost efficient manner; revenues and expenses for this segment are reflective of the continuing decrease in the size of the loan portfolio. In May 2004, the Company sold its subprime automobile and collateralized consumer loan portfolios for aggregate cash proceeds of $149,000,000 and recognized a pre-tax gain of $9,000,000, which is reflected in investment and other income. Pre-tax income for the banking and lending segment was $9,300,000 and $7,100,000 for the three month periods ended June 30, 2004 and 2003, respectively, and $14,600,000 and $11,900,000 for the six month periods ended June 30, 2004 and 2003, respectively. Finance revenues, which reflect both the level and mix of consumer instalment loans, decreased in the three and six month periods ended June 30, 2004 as compared to the similar periods in 2003 principally due to the loan portfolios sales in May 2004. Although finance revenues decreased in the 2004 periods as compared to the same periods in 2003, pre-tax results increased primarily due to a decline in the provision for loan losses, reductions in interest expense, principally resulting from reduced customer banking deposits, less interest paid on interest rate swaps and lower salaries expense resulting from the segment's restructuring efforts. Pre-tax results for the banking and lending segment in the three and six month periods ended June 30, 2003 also include gains related to the mark-to-market values of interest rate swaps of $600,000 and $2,300,000, respectively. The banking and lending segment's provision for loan losses decreased during the 2004 periods as compared to the same periods in 2003 primarily due to the sales of the loan portfolios discussed above, and lower net charge-offs. At June 30, 2004, the remaining loan portfolios aggregated $6,200,000. Manufacturing Pre-tax income for the manufacturing segment was $2,300,000 and $1,500,000 for the three month periods ended June 30, 2004 and 2003, respectively, and $3,300,000 and $1,800,000 for the six month periods ended June 30, 2004 and 2003, respectively. Manufacturing revenues increased approximately 19% and 15%, respectively, in the three and six month periods ended June 30, 2004 as compared to the same periods in 2003 reflecting increases in most of the Company's markets. The Company believes that these increases reflect a variety of factors including an improved economy, new product development and the acquisition in the first quarter of 2004 of customer receivables and inventory of a competitor that was exiting certain markets. Although raw material costs have increased in 2004, the Company has increased selling prices in most markets, which has enabled it to maintain its gross profit margins. Pre-tax results for 2004 also reflect lower operating expenses than in 2003, primarily due to workforce reductions and other cost reduction initiatives; however, pre-tax results for 2003 also include cash received from government grants. 17
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Interim Operations, continued. Domestic Real Estate Pre-tax income (loss) for the domestic real estate segment was $(5,400,000) and $7,200,000 for the three month periods ended June 30, 2004 and 2003, respectively, and $2,600,000 and $8,700,000 for the six month periods ended June 30, 2004 and 2003, respectively. Revenues during 2004 reflect decreased gains from property sales at the Company's residential and commercial project in the Florida panhandle as the lots have largely been sold, and reduced amortization of the deferred gain on the sale of CDS. However, revenues increased slightly during the six month period ended June 30, 2004 as compared to the prior year as a result of the first quarter sale of approximately 2,400 acres of unimproved land in Utah, which the Company had owned since 1997, for cash proceeds of $8,800,000. The Company recognized a $7,600,000 gain on this transaction. The pre-tax loss recognized during the second quarter of 2004 results from the recognition of a non-cash charge of approximately $7,100,000 in selling, general and other expenses to reduce the carrying amount of a commercial real estate property to its estimated fair value. The Company does not have an active program to dispose of the property and is not committed to do so; however, the Company is considering selling the property and has received a non-binding letter of intent from a third party purchaser. Accordingly, the Company has employed the held and used model to evaluate the recoverability of the property; fair value used to determine the impairment was estimated primarily based on the letter of intent. If the property is sold, the Company is likely to incur prepayment mortgage penalties of approximately $1,000,000, which have not been recorded at June 30, 2004. This property will be classified as a discontinued operation in the period in which it is either disposed of or meets the criteria for held for sale treatment. During the first and second quarters of 2004, the Company entered into agreements to sell all available lots at its 95-lot development project in South Walton County, Florida, which had a book value of $10,900,000 at June 30, 2004. These agreements were subject to the Company obtaining approval of certain project documents, and necessitated the posting of a $2,000,000 cash collateralized letter of credit. In July 2004, the Company obtained the necessary approvals, and expects it will close all of the lot sales for aggregate total sales proceeds of approximately $50,000,000 during the third quarter of 2004. The Company will be required under the sale agreements to make significant improvements to the property (which are not reflected in its current book value), including infrastructure and certain amenities, which it expects to complete in 2005. Revenue and profit relating to this project will be deferred using the percentage of completion method of accounting. Corporate and Other Operations During 2004, substantially all of the Company's net securities gains (losses) reflect realized gains from the sale of publicly traded debt and equity securities that had been classified as Corporate available for sale securities. Net securities gains (losses) for the three and six month periods ended June 30, 2003 include a provision of $2,400,000 and $5,100,000, respectively, to write down the Company's investments in certain available for sale securities and a non-public security. Such write downs were $600,000 for the 2004 periods. Investment and other income was largely unchanged year-to-date in 2004 and declined in the second quarter of 2004 as compared to the same periods in 2003. The decline principally relates to the recording in the 2003 periods of $4,900,000 relating to a refund of foreign taxes not based on income and related interest and a gain of $1,500,000 from the sale of a portion of the Company's interest in Olympus Re. The three and six month 2004 periods reflect increased income of $4,000,000 and $3,000,000, respectively, related to the accounting for mark-to-market values of Corporate derivatives, greater revenues from the Company's gas and winery operations and miscellaneous other income. 18
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Interim Operations, continued. The increase in interest expense in the 2004 periods as compared to the 2003 periods primarily reflects interest expense relating to the $375,000,000 aggregate principal amount of the 7% Senior Notes, the $350,000,000 principal amount of its 3 3/4% Convertible Senior Subordinated Notes and dividends accrued on its trust issued preferred securities, which commencing July 1, 2003 are classified as interest expense (shown as minority interest in prior periods) as a result of the implementation of Statement of Financial Accounting Standards No. 150. For the six month period 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 a federal income tax benefit recognized on losses in other comprehensive income. 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. Income taxes for the 2003 periods differ from the expected statutory federal rate principally due to the exclusion of the income related to the refund of foreign taxes not based on income discussed above. Associated Companies Equity in income (losses) of associated companies for the three and six month periods ended June 30, 2004 and 2003 includes the following (in thousands): <TABLE> <CAPTION> For the Three Month For the Six Month Period Ended June 30, Period Ended June 30, --------------------- --------------------- 2004 2003 2004 2003 ------ -------- -------- ------- <S> <C> <C> <C> <C> Berkadia $ -- $ 4,500 $ 800 $ 27,300 Olympus Re Holdings, Ltd. 7,200 10,200 15,500 22,500 WilTel -- (22,300) -- (57,100) EagleRock Capital Partners (QP), LP 1,600 14,200 5,900 14,300 Jefferies Partners Opportunity Fund II, LLC 4,300 3,400 8,700 6,900 HomeFed Corporation 1,700 7,800 3,700 7,100 Pershing 3,100 -- 6,000 -- Other 1,400 (1,800) 2,700 (900) -------- -------- -------- -------- Pre-tax 19,300 16,000 43,300 20,100 Income tax expense 15,200 13,500 15,200 27,200 -------- -------- -------- -------- Equity in income (losses), net of taxes $ 4,100 $ 2,500 $ 28,100 $ (7,100) ======== ======== ======== ======== </TABLE> Since the Berkadia loan was fully repaid during the first quarter of 2004, the Company will no longer have any income related to the Berkadia loan in the future. The reduction in the Company's equity in income of Olympus Re reflects the reduction in the Company's ownership interest in June 2003 as discussed in the 2003 10-K. As more fully discussed in the 2003 10-K, WilTel became a consolidated subsidiary in November 2003 and the Company ceased applying the equity method of accounting at that time. 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 forward-looking statements are made pursuant to the safe-harbor provisions of the Private Securities Litigation Reform Act of 1995. 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. 19
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Interim Operations, continued. 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 such statements 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 business, 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 our real estate development activities and telecommunications business, as well as our other operations; 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 reinsure certain risks economically, which could result in us having to self-insure business risks; Changes in U.S. real estate markets, including the residential market in Southern California and the commercial market in Washington, D.C., which are sensitive to mortgage interest rate levels, and the vacation market in Hawaii; Adverse economic, political or environmental developments in Spain, which could delay or preclude the issuance of permits necessary to develop the Company's copper mineral rights or which could result in increased costs of bringing the project to completion and increased costs in financing the development of the project; 20
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Interim Operations, continued. The inability to obtain the necessary financing for the Las Cruces copper mining project, which could delay or prevent completion of the project; Decreases in world wide copper prices, which could adversely affect the commercial viability of our mineral rights in Spain; WilTel's dependence on a small number of suppliers and high-volume customers (including SBC), 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; 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; 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; Changes in economic conditions including those affecting real estate and other collateral values, the continued financial stability of the Company's borrowers and their ability to make loan principal and interest payments; Regional or general increases in the cost of living, particularly in the regions in which we have operations or sell our products or services, which may result in lower sales of such products and service; and Risks associated with future acquisitions and investments, including changes in the composition of our assets and liabilities through such acquisitions, 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. The Company does not undertake any 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. 21
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, 2003, and is incorporated by reference herein. Item 4. 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, 2004. 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, 2004. (b) There were no changes in the Company's internal controls 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, 2004, that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting. As a result of Section 404 of the Sarbanes-Oxley Act of 2002 and the rules issued thereunder, the Company will be required to include in its Annual Report on Form 10-K for the year ending December 31, 2004 a report on management's assessment of the effectiveness of the Company's internal controls over financial reporting. The Company's independent registered public accountants will also be required to attest to and report on management's assessment. As part of the process of preparing for compliance with these requirements, in 2003, the Company initiated a review of its internal controls over financial reporting. As part of this review, management has been engaged in a process to document and evaluate the Company's internal controls over financial reporting. In this regard, management has dedicated internal resources, engaged outside consultants and adopted a detailed plan to (i) document the Company's internal controls over financial reporting, (ii) assess the adequacy of the Company's internal controls over financial reporting, (iii) take steps to improve control processes where appropriate and (iv) validate through testing that controls are functioning as documented. This documentation, evaluation and testing process will continue throughout the remainder of this year. There can be no assurance that deficiencies or weaknesses in the design or operation of internal controls over financial reporting will not be found and, if found, that the Company will have sufficient time to remediate any such deficiencies or weaknesses and perform testing procedures before the end of the year. The Company believes that any system of internal accounting controls, no matter how well designed and operated, can provide only reasonable (and not absolute) assurance that all of its objectives will be met, including the detection of fraud. Furthermore, no evaluation of internal accounting controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected. 22
PART II - OTHER INFORMATION Item 2. On April 29, 2004, the Company sold $350,000,000 principal amount of its 3 3/4% Convertible Notes in a private transaction pursuant to Rule 4(2) under the Securities Act of 1933. Jefferies & Company, Inc. was the initial purchaser of the notes, which were immediately resold by Jefferies & Company, Inc. to buyers who represented themselves to be qualified institutional investors. The aggregate offering price was $350,000,000 and the aggregate underwriting discount was $8,165,500. The notes are convertible into the Company's common shares at any time before their maturity, subject to certain restrictions contained in the notes, at a conversion rate of 14.5138 shares per each $1,000 principal amount of notes (an aggregate of 5,079,830 shares), subject to adjustment. The net cash proceeds from the sale of the notes are being used for general corporate purposes. The Company is obligated to file a shelf registration statement in respect of the notes and the common shares issuable upon conversion of the notes. 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 2004 Annual Meeting of Shareholders held on May 11, 2004. a) Election of directors. <TABLE> <CAPTION> Number of Shares ---------------- For Withheld ---------- -------- <S> <C> <C> Ian M. Cumming 59,506,577 230,322 Paul M. Dougan 59,356,894 380,005 Lawrence D. Glaubinger 59,355,555 381,344 Alan J. Hirschfield 59,602,560 134,339 James E. Jordan 59,253,114 483,785 Jeffrey C. Keil 59,602,678 134,221 Jesse Clyde Nichols, III 59,356,894 380,005 Joseph S. Steinberg 59,504,931 231,968 </TABLE> b) Approval of an amendment to the Company's certification of incorporation extending the expiration date of certain restrictions on the transferability of the Company's common shares to December 31, 2024. For 47,967,591 Against 1,491,524 Abstentions 109,892 Broker non votes 10,167,892 c) Ratification of PricewaterhouseCoopers LLP, as independent auditors for the year ended December 31, 2004. For 59,112,457 Against 565,024 Abstentions 59,418 Broker non votes -- 23
Item 6. Exhibits and Reports on Form 8-K. a) Exhibits. 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. b) Reports on Form 8-K. The Company filed current reports on Form 8-K dated April 21, 2004, which set forth information under Item 9. Regulation FD Disclosure, and on April 22, 2004 and May 7, 2004, which set forth information under Item 5. Other Events and Item 7. Financial Statements and Exhibits. 24
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 6, 2004 By: /s/ Barbara L. Lowenthal ----------------------------- Barbara L. Lowenthal Vice President and Comptroller (Chief Accounting Officer) 25
Exhibit Index 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.