SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------------
FORM 10-K/A
(AMENDMENT NO. 1)
[x] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 2007
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 (I.R.S. Employer Identification No.)
of Incorporation or Organization)
315 Park Avenue South
New York, New York 10010
(212) 460-1900
(Address, Including Zip Code, and Telephone Number, Including Area Code,
of Registrant's Principal Executive Offices)
Securities registered pursuant to Section 12(b) of the Act:
Name of Each Exchange
Title of Each Class on Which Registered
-------------------------------------- ------------------------
Common Shares, par value $1 per share New York Stock Exchange
7-3/4% Senior Notes due August 15, 2013 New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act:
None.
(Title of Class)
Indicate by check mark if the registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities Act. Yes [x] No [ ]
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Act. Yes [ ] No [x]
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 if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statement
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K [x].
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
definitions of "large accelerated filer," "accelerated filer," and "smaller
reporting company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer [x] Accelerated filer [ ]
Non-accelerated filer [ ] Smaller reporting company [ ]
(Do not check if a smaller reporting company)
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes [ ] No [x]
Aggregate market value of the voting stock of the registrant held by
non-affiliates of the registrant at June 30, 2007 (computed by reference to the
last reported closing sale price of the Common Shares on the New York Stock
Exchange on such date): $5,753,522,000.
On February 14, 2008, the registrant had outstanding 222,575,940 Common Shares.
DOCUMENTS INCORPORATED BY REFERENCE:
Certain portions of the registrant's definitive proxy statement pursuant to
Regulation 14A of the Securities Exchange Act of 1934 in connection with the
2008 annual meeting of shareholders of the registrant are incorporated by
reference into Part III of this Report.
1
EXPLANATORY NOTE
This Report on Form 10-K/A amends and restates in its entirety Item 15
of the Annual Report on Form 10-K, of Leucadia National Corporation (the
"Company") for the fiscal year ended December 31, 2007 to reflect that the
financial statements referred to in Item 15(c)(1), (2), (3), (4), (5) and (6)
have been filed herewith pursuant to Item 3-09(b) of Regulation S-X.
2
PART IV
Item 15. Exhibits and Financial Statement Schedule.
-------- ------------------------------------------
(a)(1)(2) Financial Statements and Schedule.
Report of Independent Registered Public Accounting Firm..................................... F-1
Financial Statements:
Consolidated Balance Sheets at December 31, 2007 and 2006.................................. F-3
Consolidated Statements of Operations for the years ended December 31, 2007,
2006 and 2005........................................................................... F-4
Consolidated Statements of Cash Flows for the years ended December 31, 2007,
2006 and 2005........................................................................... F-5
Consolidated Statements of Changes in Shareholders' Equity for the years ended
December 31, 2007, 2006 and 2005........................................................ F-7
Notes to Consolidated Financial Statements................................................. F-8
Financial Statement Schedule:
Schedule II - Valuation and Qualifying Accounts............................................ F-46
(3) Executive Compensation Plans and Arrangements. See Item 15(b)
below for a complete list of Exhibits to this Report.
1999 Stock Option Plan, as amended April 5, 2006 (filed as Annex
C to the Company's Proxy Statement dated April 17, 2006 (the
"2006 Proxy Statement")).
Form of Grant Letter for the 1999 Stock Option Plan (filed as
Exhibit 10.4 to the Company's Annual Report on Form 10-K for the
fiscal year ended December 31, 2004 (the "2004 10-K")).
Amended and Restated Shareholders Agreement dated as of June 30,
2003 among the Company, Ian M. Cumming and Joseph S. Steinberg
(filed as Exhibit 10.5 to the Company's Annual Report on Form
10-K for the fiscal year ended December 31, 2003 (the "2003
10-K")).
Form of Amendment No. 1 to the Amended and Restated Shareholders
Agreement dated as of June 30, 2003 (filed as Exhibit 10.6 to the
Company's Quarterly Report on Form 10-Q for the fiscal quarter
ended June 30, 2006 (the "2nd Quarter 2006 10-Q")).
Leucadia National Corporation 2003 Senior Executive Annual
Incentive Bonus Plan, as amended May 16, 2006 (filed as Annex A
to the 2006 Proxy Statement).
Leucadia National Corporation 2006 Senior Executive Warrant Plan
(filed as Annex B to the 2006 Proxy Statement).
Employment Agreement made as of June 30, 2005 by and between the
Company and Ian M. Cumming (filed as Exhibit 99.1 to the
Company's Current Report on Form 8-K dated July 13, 2005 (the
"July 13, 2005 8-K")).
Employment Agreement made as of June 30, 2005 by and between the
Company and Joseph S. Steinberg (filed as Exhibit 99.2 to the
July 13, 2005 8-K).
3
(b) Exhibits.
We will furnish any exhibit upon request made to our Corporate Secretary,
315 Park Avenue South, New York, NY 10010. We charge $.50 per page to cover
expenses of copying and mailing.
3.1 Restated Certificate of Incorporation (filed as Exhibit 5.1 to
the Company's Current Report on Form 8-K dated
July 14, 1993).*
3.2 Certificate of Amendment of the Certificate of Incorporation
dated as of May 14, 2002 (filed as Exhibit 3.2 to the
2003 10-K).*
3.3 Certificate of Amendment of the Certificate of Incorporation
dated as of December 23, 2002 (filed as Exhibit 3.2 to the
Company's Annual Report on Form 10-K for the fiscal year ended
December 31, 2002 (the "2002 10-K")).*
3.4 Amended and Restated By-laws as amended through December 17,
2007 (filed as Exhibit 3.1 to the Company's Current Report on
Form 8-K dated December 17, 2007).*
3.5 Certificate of Amendment of the Certificate of Incorporation
dated as of May 13, 2004 (filed as Exhibit 3.5 to the
Company's 2004 10-K).*
3.6 Certificate of Amendment of the Certificate of Incorporation
dated as of May 17, 2005 (filed as Exhibit 3.5 to the
Company's Annual Report on Form 10-K for the fiscal year ended
December 31, 2005 (the "2005 10-K")).*
3.7 Certificate of Amendment of the Certificate of Incorporation
dated as of May 15, 2007.
4.1 The Company undertakes to furnish the Securities and Exchange
Commission, upon written request, a copy of all instruments
with respect to long-term debt not filed herewith.
10.1 1999 Stock Option Plan, as amended April 5, 2006 (filed as
Annex A to the 2006 Proxy Statement).*
10.2 Form of Grant Letter for the 1999 Stock Option Plan (filed as
Exhibit 10.4 to the Company's 2004 10-K).*
10.3 Amended and Restated Shareholders Agreement dated as of
June 30, 2003 among the Company, Ian M. Cumming and Joseph
S. Steinberg (filed as Exhibit 10.5 to the 2003 10-K).*
10.4 Services Agreement, dated as of January 1, 2004, between the
Company and Ian M. Cumming (filed as Exhibit 10.37 to
the 2005 10-K).*
10.5 Services Agreement, dated as of January 1, 2004, between the
Company and Joseph S. Steinberg (filed as Exhibit 10.38
to the 2005 10-K).*
10.6 Leucadia National Corporation 2003 Senior Executive Annual
Incentive Bonus Plan, as amended May 16, 2006 (filed as
Annex A to the 2006 Proxy Statement).*
10.7 Employment Agreement made as of June 30, 2005 by and between
the Company and Ian M. Cumming (filed as Exhibit 99.1
to the July 13, 2005 8-K).*
10.8 Employment Agreement made as of June 30, 2005 by and between
the Company and Joseph S. Steinberg (filed as Exhibit
99.2 to the July 13, 2005 8-K).*
4
10.9 First Amended Joint Chapter 11 Plan of Reorganization of
Williams Communications Group, Inc. ("WCG") and CG Austria,
Inc. filed with the Bankruptcy Court as Exhibit 1 to the
Settlement Agreement (filed as Exhibit 99.3 to the Current
Report on Form 8-K of WCG dated July 31, 2002 (the "WCG July
31, 2002 8-K")).*
10.10 Tax Cooperation Agreement between WCG and The Williams
Companies Inc. dated July 26, 2002, filed with the Bankruptcy
Court as Exhibit 7 to the Settlement Agreement (filed as
Exhibit 99.9 to the WCG July 31, 2002 8-K).*
10.11 Exhibit 1 to the Agreement and Plan of Reorganization between
the Company and TLC Associates, dated February 23, 1989 (filed
as Exhibit 3 to Amendment No. 12 to the Schedule 13D dated
December 29, 2004 of Ian M. Cumming and Joseph S. Steinberg
with respect to the Company).*
10.12 Information Concerning Executive Compensation (filed as
Exhibit 10.1 to the Company's Current Report on Form 8-K
dated January 11, 2007).*
10.13 Form of Unit Purchase Agreement, dated as of April 6, 2006, by
and among GAR, LLC, the Company, AA Capital Equity Fund, L.P.,
AA Capital Biloxi Co-Investment Fund, L.P. and HRHC Holdings,
LLC (filed as Exhibit 10.1 to the 2nd Quarter 2006 10-Q).*
10.14 Form of Loan Agreement, dated as of April 6, 2006, by and
among Goober Drilling, LLC, the Subsidiaries of Goober
Drilling, LLC from time to time signatory thereto and the
Company (filed as Exhibit 10.2 to the 2nd Quarter 2006 10-Q).*
10.15 Form of First Amendment to Loan Agreement, dated as of June
15, 2006, between Goober Drilling, LLC, the Subsidiaries of
Goober Drilling, LLC from time to time signatory thereto and
the Company (filed as Exhibit 10.3 to the 2nd Quarter 2006
10-Q).*
10.16 Form of First Amended and Restated Limited Liability Company
Agreement of Goober Drilling, LLC, dated as of June 15, 2006,
by and among Goober Holdings, LLC, Baldwin Enterprises, Inc.,
the Persons that become Members from time to time, John
Special, Chris McCutchen, Jim Eden, Mike Brown and Goober
Drilling Corporation (filed as Exhibit 10.4 to the 2nd Quarter
2006 10-Q).*
10.17 Form of Purchase and Sale Agreement, dated as of May 3, 2006,
by and among LUK-Symphony Management, LLC, Symphony Health
Services, LLC and RehabCare Group, Inc. (filed as Exhibit 10.5
to the 2nd Quarter 2006 10-Q).*
10.18 Form of Amendment No. 1, dated as of May 16, 2006, to the
Amended and Restated Shareholders Agreement dated as of June
30, 2003, by and among Ian M. Cumming, Joseph S. Steinberg and
the Company (filed as Exhibit 10.6 to the 2nd Quarter 2006
10-Q).*
10.19 Form of Credit Agreement, dated as of June 28, 2006, by and
among the Company, the various financial institutions and
other Persons from time to time party thereto and JPMorgan
Chase Bank, National Association (filed as Exhibit 10.7 to the
2nd Quarter 2006 10-Q).*
10.20 Form of Subscription Agreement, dated as of July 15, 2006, by
and among FMG Chichester Pty Ltd, the Company, and Fortescue
Metals Group Ltd (filed as Exhibit 10.1 to the Company's
Quarterly Report on Form 10-Q for the quarterly period ended
September 30, 2006 (the "3rd Quarter 2006 10-Q")).*
10.21 Form of Amending Agreement, dated as of August 18, 2006, by
and among FMG Chichester Pty Ltd, the Company and Fortescue
Metals Group Ltd (filed as Exhibit 10.2 to the 3rd Quarter
2006 10-Q).*
5
10.22 Compensation Information Concerning Non-Employee Directors
(filed under item 1.01 of the Company's Current Report on
Form 8-K dated May 22, 2006).*
10.23 Leucadia National Corporation 2006 Senior Executive Warrant
Plan (filed as Annex B to the 2006 Proxy Statement).*
10.24 Asset Purchase and Contribution Agreement, dated as of
January 23, 2007, by and among Baldwin Enterprises, Inc., STi
Prepaid, LLC, Samer Tawfik, Telco Group, Inc., STi Phonecard
Inc., Dialaround Enterprises Inc., STi Mobile Inc., Phonecard
Enterprises Inc.,VOIP Enterprises Inc., STi PCS, LLC, Tawfik &
Partners, SNC, STiPrepaid & Co., STi Prepaid Distributors &
Co. and ST Finance, LLC (filed as Exhibit 10.1 to the
Company's Quarterly Report on Form 10-Q for the quarterly
period ended March 31, 2007 (the "1st Quarter 2007 10-Q")).*
10.25 Registration Rights Agreement, dated as of March 8, 2007,
among STi Prepaid, LLC and ST Finance, LLC (filed as
Exhibit 10.2 to the 1st Quarter 2007 10-Q).*
10.26 Amended and Restated Limited Liability Company Agreement,
dated as of March 8, 2007, by and among STi Prepaid, LLC, BEI
Prepaid, LLC and ST Finance, LLC (filed as Exhibit 10.3 to the
1st Quarter 2007 10-Q).*
10.27 Master Agreement for the Formation of a Limited Liability
Company dated as of February 28, 2007, among Jefferies Group,
Inc., Jefferies & Company, Inc. and Leucadia National
Corporation (filed as Exhibit 10.4 to the 1st Quarter 2007
10-Q).*
10.28 Amended and Restated Limited Liability Company Agreement of
Jefferies High Yield Holdings, LLC, dated as of April 2, 2007,
by and among Jefferies Group, Inc., Jefferies & Company, Inc.,
Leucadia National Corporation, Jefferies High Yield Partners,
LLC, Jefferies Employees Opportunity Fund LLC and Jefferies
High Yield Holdings, LLC (filed as Exhibit 10.5 to the 1st
Quarter 10-Q).*
10.29 Stock Purchase Agreement by and among BEI-RZT Corporation,
Gaylord Hotels, Inc. and Gaylord Entertainment Company
(Mainland Agreement), dated June 1, 2007 (filed as Exhibit
10.1 to the Company's Quarterly Report on Form 10-Q for the
quarterly period ended June 30, 2007).*
21 Subsidiaries of the registrant (filed as Exhibit 21 to the
Company's Annual Report on Form 10-K for the fiscal year ended
December 31, 2007 (the "2007 10-K").*
23.1 Consent of PricewaterhouseCoopers LLP with respect to the
incorporation by reference into the Company's Registration
Statements on Form S-8 (No. 333-51494), Form S-8 (No.
333-143770), and Form S-3 (No. 333-145668) (filed as Exhibit
23.1 to the Company's 2007 10-K).*
23.2 Consent of PricewaterhouseCoopers, with respect to the
inclusion in this Annual Report on Form 10-K of the financial
statements of Olympus Re Holdings, Ltd. and with respect to
the incorporation by reference in the Company's
Registration Statements on Form S-8 (No. 333-51494), Form S-8
(No. 333-143770), and Form S-3 (No. 333-145668).
6
23.3 Consent of independent auditors from BDO Seidman, LLP with
respect to the inclusion in this Annual Report on Form 10-K of
the financial statements of EagleRock Capital Partners (QP),
LP and EagleRock Master Fund, LP and with respect to the
incorporation by reference in the Company's Registration
Statements on Form S-8 (No. 333-51494), Form S-8 (No.
333-143770), and Form S-3 (No. 333-145668).
23.4 Independent Auditors' Consent from KPMG LLP, with respect to
the inclusion in this Annual Report on Form 10-K of the
financial statements of Jefferies Partners Opportunity Fund
II, LLC and with respect to the incorporation by reference
into the Company's Registration Statements on Form S-8 (No.
333-51494), Form S-8 (No. 333-143770), and Form S-3 (No.
333-145668).
23.5 Consent of independent auditors from Ernst & Young, with
respect to the inclusion in this Annual Report on Form 10-K of
the financial statements of Pershing Square IV, L.P. and
Pershing Square IV A, L.P. and with respect to the
incorporation by reference in the Company's Registration
Statements on Form S-8 (No. 333-51494), Form S-8 (No.
333-143770), and Form S-3 (No. 333-145668).
23.6 Consent of independent auditors from PricewaterhouseCoopers
LLP, with respect to the inclusion in this Annual Report on
Form 10-K of the financial statements of Premier Entertainment
Biloxi, LLC and with respect to the incorporation by reference
in the Company's Registration Statements on Form S-8 (No.
333-51494), Form S-8 (No.333-143770), and Form S-3
(No. 333-145668).
23.7 Consent of independent auditors from PricewaterhouseCoopers
LLP, with respect to the inclusion in this Annual Report on
Form 10-K of the financial statements of HFH ShortPLUS Fund,
L.P. and HFH ShortPLUS Master Fund, Ltd. and with respect to
the incorporation by reference in the Company's Registration
Statements on Form S-8 (No.333-51494), Form S-8
(No. 333-143770), and Form S-3 (No. 333-145668).
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.*
31.4 Certification of Chairman of the Board and Chief Executive
Officer pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.
31.5 Certification of President pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
31.6 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 Principal Financial Officer pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.*
32.4 Certification of Chairman of the Board and Chief Executive
Officer pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.**
32.5 Certification of President pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.**
32.6 Certification of Principal Financial Officer pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.**
7
(c) Financial statement schedules.
(1) Olympus Re Holdings, Ltd. consolidated financial
statement for the year ended December 31, 2005.**
(2) EagleRock Capital Partners (QP), LP financial
statements as of December 31, 2007 and 2006 and for the
years ended December 31, 2007, 2006 and 2005 and
EagleRock Master Fund, LP financial statements as of
December 31, 2007 and 2006 and for the years ended
December 31, 2007, 2006 and 2005.**
(3) Jefferies Partners Opportunity Fund II, LLC financial
statements as of and for the period ended March 31,
2007 (unaudited), as of and for the year ended December
31, 2006 (unaudited), and as of and for the year ended
December 31, 2005 (audited).**
(4) Pershing Square IV, L.P. financial statements as of
December 31, 2007 and for the period from June 1, 2007
(commencement of operations) to December 31, 2007 and
Pershing Square IV A, L.P. financial statements as of
December 31, 2007 and for the period from June 1, 2007
(commencement of operations) to December 31, 2007.**
(5) Premier Entertainment Biloxi, LLC financial statements
as of and for the year ended December 31, 2006
(unaudited) and as of August 9, 2007 and for the period
from January 1, 2007 through August 9, 2007 (audited).**
(6) HFH ShortPLUS Fund, L.P. financial statements as of
December 31, 2007 and for the year ended December
31, 2007 and HFH ShortPLUS Master Fund, Ltd. financial
statements as of December 31, 2007 and for the year
ended December 31, 2007.**
----------------------------
* Incorporated by reference.
** Furnished herewith pursuant to item 601(b)(32) of Regulation S-K.
8
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
LEUCADIA NATIONAL CORPORATION
March 28, 2008 By: /s/ Barbara L. Lowenthal
------------------------
Barbara L. Lowenthal
Vice President and Comptroller
9
OLYMPUS RE HOLDINGS, LTD.
(Incorporated in Bermuda)
Consolidated Financial Statements
DECEMBER 31, 2005
(expressed in U.S. dollars)
[PricewaterhouseCoopers Logo]
--------------------------------------------------------------------------------
PricewaterhouseCoopers
Chartered Accountants
Dorchester House
7 Church Street
Hamilton HM 11
Bermuda
Telephone +1 (441) 295-2000
Facsimile +1 (441) 295-1242
www.pwc.com/bermuda
REPORT OF INDEPENDENT AUDITORS
To the Shareholders of Olympus Re Holdings, Ltd.
In our opinion, the accompanying consolidated statements of income,
shareholder's equity, comprehensive income and cash flows present fairly, in all
material respects, the results of operations and cash flows of Olympus Re
Holdings, Ltd. for the year ended December 31, 2005 in conformity with
accounting principles generally accepted in the United States of America. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audit. We conducted our audit of these statements in accordance with
auditing standards generally accepted in the United States of America. Those
standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audit provides a reasonable basis for our opinion.
/s/ PricewaterhouseCoopers
Chartered Accountants
MARCH 2, 2006
A list of partners can be obtained from the above address
PricewaterhouseCoopers refers to the members of the worldwide
PricewaterhouseCoopers organisation
OLYMPUS RE HOLDINGS, LTD.
Consolidated Statement of Income
FOR THE YEAR ENDED DECEMBER 31, 2005
--------------------------------------------------------------------------------
(expressed in U.S. dollars)
2005
$
---------------
REVENUES
Gross premiums written 518,811,790
---------------
Net premiums written 518,811,790
Net change in unearned premiums 36,220,238
---------------
Net premiums earned 555,032,028
Net investment income 34,531,532
Net realized losses on investments (16,882,643)
---------------
TOTAL REVENUES 572,680,917
===============
EXPENSES
Losses and loss expenses (note 3) 1,026,331,103
Commissions 128,348,583
Premium taxes and fees 4,341,284
Other underwriting expenses 7,882,461
General and administrative expenses 2,383,140
---------------
TOTAL EXPENSES 1,169,286,571
===============
NET LOSS FOR THE YEAR (596,605,654)
===============
The accompanying notes are an integral part of these consolidated financial
statements.
OLYMPUS RE HOLDINGS, LTD.
Consolidated Statement of Shareholders' Equity
FOR THE YEAR ENDED DECEMBER 31, 2005
------------------------------------------------------------------------------
(expressed in U.S. dollars)
ACCUMULATED
COMMON ADDITIONAL OTHER RETAINED TOTAL
VOTING PAID-IN COMPREHENSIVE EARNINGS SHAREHOLDERS'
SHARES CAPITAL INCOME (DEFICIT) EQUITY
$ $ $ $ $
--------------------------------------------------------------------------
BALANCE AS OF DECEMBER 31, 2004 37,164 371,600,636 2,978,377 278,795,415 653,411,592
Net loss for the year -- -- -- (596,605,654) (596,605,654)
Change in unrealized depreciation on
marketable investments -- -- (845,786) -- (845,786)
Repurchase of common voting
shares (1,971) (19,706,829) -- (14,943,212) (34,652,012)
--------------------------------------------------------------------------
BALANCE AS OF DECEMBER 31, 2005 35,193 351,893,807 2,132,591 (332,753,451) 21,308,140
==========================================================================
The accompanying notes are an integral part of these consolidated financial
statements.
OLYMPUS RE HOLDINGS, LTD.
Consolidated Statement of Comprehensive Income
FOR THE YEAR ENDED DECEMBER 31, 2005
------------------------------------------------------------------------------
(expressed in U.S. dollars)
2005
$
-------------
NET LOSS FOR THE YEAR (596,605,654)
OTHER COMPREHENSIVE LOSS
Change in unrealized depreciation on marketable
investments (845,786)
-------------
COMPREHENSIVE LOSS FOR THE YEAR (597,451,440)
=============
The accompanying notes are an integral part of these consolidated financial
statements.
OLYMPUS RE HOLDINGS, LTD.
Consolidated Statement of Cash Flows
FOR THE YEAR ENDED DECEMBER 31, 2005
------------------------------------------------------------------------------
(expressed in U.S. dollars)
2005
$
-------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss for the year (596,605,654)
Adjustments to reconcile net loss
to net provided by operating activities
Loss on sale of investments 16,882,643
Net amortization of premium on fixed
maturities 2,324,210
Investment income accrued (266,549)
Accounts and premiums receivable (24,663,081)
Deferred acquisition costs 12,946,436
Other assets (80,833)
Loss and loss adjustment expense reserves 724,972,054
Unearned premiums (36,220,238)
Accounts payable and accrued expenses 129,047
Advisory fees payable (9,238,385)
-------------
Cash provided by operating activities 90,179,650
-------------
CASH FLOWS FOR INVESTING ACTIVITIES
Purchase of investments (911,493,880)
Proceeds from sales of investments (net of
investments trade pending) 830,894,757
-------------
Cash used in investing activities (80,599,123)
-------------
CASH FLOWS FOR FINANCING ACTIVITIES
Repurchase of common shares (34,652,012)
Deferred capital raise expenditures (1,434,635)
Accrued capital raise expenditures 653,552
Share subscriptions received in advance 32,740,242
-------------
Cash used in financing activities (2,692,853)
-------------
INCREASE IN CASH AND CASH EQUIVALENTS 6,887,674
CASH AND CASH EQUIVALENTS - BEGINNING OF YEAR 50,929,556
-------------
CASH AND CASH EQUIVALENTS - END OF YEAR 57,817,230
=============
The accompanying notes are an integral part of these consolidated financial
statements.
OLYMPUS RE HOLDINGS, LTD.
Notes to Consolidated Financial Statements
FOR THE YEAR ENDED DECEMBER 31, 2005
--------------------------------------------------------------------------------
(expressed in U.S. dollars)
1. NATURE OF THE BUSINESS
Olympus Re Holdings, Ltd. and its principal operating subsidiary Olympus
Reinsurance Company, Ltd. ("Olympus Re") were incorporated under the laws
of Bermuda on December 3, 2001 and commenced operations on January 1,
2002. On December 22, 2005 Olympus Re Holdings, Ltd. incorporated a new
subsidiary, Helicon Re Holdings, Ltd. ("Helicon") together with Helicon's
wholly-owned operating subsidiary Helicon Reinsurance Company, Ltd.
("Helicon Re") (see note 10) (Olympus Re Holdings, Ltd. and its
subsidiaries are referred to as "the Company"). Olympus Re is registered
as a Class 4 insurer under The Insurance Act 1978, amendments thereto and
related regulations ("The Act"). Helicon Re did not commence operations
prior to December 31, 2005.
The Company's bye-laws provide that the Board of Directors of Olympus Re
shall consist of persons who first have been elected as designated
directors by a resolution in a general meeting of the shareholders of the
Company. The Board of Directors of the Company must then vote all shares
of Olympus Re owned by the Company to elect such designated directors as
Olympus Re directors. The bye-law provisions with respect to the removal
of directors of Olympus Re operate similarly.
The Company, through Olympus Re, writes reinsurance business on a global
basis with an emphasis on property excess business. During the year ended
December 31, 2005, this was through two main sources, quota share
reinsurance agreements with a U.S. reinsurance company and a Swedish
reinsurance company (see note 5) and underwriting advisory contracts. The
purpose of these quota share agreements is to produce primarily property
reinsurance. Olympus Re's underwriting advisory contracts are with
non-U.S. advisors to recommend excess property and marine reinsurance
business and consult on the quota share agreements. The non-U.S. advisors
are related to the previously mentioned U.S. and Swedish reinsurance
companies through common ownership.
2. SIGNIFICANT ACCOUNTING POLICIES
These consolidated financial statements have been prepared in accordance
with accounting principles generally accepted in the United States of
America. The preparation of financial statements in accordance with
generally accepted accounting principles requires management to make
estimates and assumptions that affect reported amounts of assets and
liabilities, as well as disclosure of contingent assets and liabilities as
at the balance sheet date. Estimates also affect the reported amounts of
income and expenses for the reporting period. Actual results could differ
from those estimates.
The following is a summary of the significant accounting policies adopted
by the Company:
(a) CONSOLIDATION
The consolidated financial statements include the financial
statements of the Company and its wholly-owned subsidiaries Olympus
Re and Helicon. All significant inter-company balances and
transactions have been eliminated on consolidation.
(1)
OLYMPUS RE HOLDINGS, LTD.
Notes to Consolidated Financial Statements
FOR THE YEAR ENDED DECEMBER 31, 2005
--------------------------------------------------------------------------------
(expressed in U.S. dollars)
(b) PREMIUMS AND UNEARNED PREMIUMS
The Company records premiums for the quota share treaties based on
cession statements received. Premiums are earned evenly over the
term of the underlying reinsurance contract, in proportion to the
risk assumed. The portion of the premium related to the unexpired
portion of the contract at the end of the fiscal period is reflected
in unearned premiums.
Other reinsurance premiums assumed are estimated at the inception of
the policy based on information provided by the underlying ceding
companies. The information used in establishing these estimates is
reviewed and subsequent adjustments are taken into income in the
period in which they are determined. These premiums are earned on a
pro-rata basis over the terms of the related reinsurance contracts.
Reinstatement premiums are recognized at the time a loss event
occurs where coverage limits for the remaining life of the contract
are reinstated under pre-defined contract terms and are fully earned
when recognized. Accrual of reinstatement premiums is based on the
cession statements received or information provided by the
underlying ceding companies.
(c) DEFERRED ACQUISITION COSTS
The Company records acquisition costs based on cessions statements
received, in addition to its own direct acquisition costs.
Policy acquisition costs are comprised of ceding commissions,
brokerage, premium taxes and other expenses that relate directly to
the acquisition of premiums. These costs are deferred and amortized
over the terms of the related contracts on a pro-rata basis.
Deferred policy acquisition costs are reviewed to determine if they
are recoverable from future underwriting profits, including
investment income. If such costs are estimated to be unrecoverable,
they are expensed.
(d) LOSS AND LOSS ADJUSTMENT EXPENSE RESERVES
The Company records loss and loss adjustment expenses based on
cessions statements received. Loss and loss adjustment expense
reserves, including losses incurred but not reported and provisions
for settlement expenses, include amounts determined from losses
reported to the Company, and management estimates. Due to limited
historical experience, industry data is relied upon in the reserving
process.
A significant portion of the Company's business is in the property
catastrophe market and programs with higher layers of risks.
Reserving for losses in such programs is inherently complicated in
that losses in excess of the attachment level of the underlying
policies are characterized by high severity and low frequency. This
limits the volume of industry claims experience available from which
to reliably predict ultimate losses following a loss event.
(2)
OLYMPUS RE HOLDINGS, LTD.
Notes to Consolidated Financial Statements
FOR THE YEAR ENDED DECEMBER 31, 2005
--------------------------------------------------------------------------------
(expressed in U.S. dollars)
The Company uses industry data and professional judgment to estimate
the ultimate loss from reinsurance contracts exposed to a loss
event. Delays in reporting losses to the Company together with the
potential for unforeseen adverse developments may result in losses
and loss expenses significantly greater or less than the reserve
provided at the time of the loss event.
Loss and loss adjustment expense reserve estimates are regularly
reviewed and updated, as new information becomes known to the
Company. Any resulting adjustments are included in income in the
period in which they become known.
(e) CASH AND CASH EQUIVALENTS
Cash and cash equivalents include time deposits with original
maturities of three months or less.
(f) INVESTMENTS
The Company's investments in fixed maturities are classified as
"available-for-sale" and are carried at fair value, based on quoted
market prices. Unrealized gains and losses are included within
accumulated other comprehensive income in shareholders' equity.
Net investment income is stated net of investment management and
custody fees. Interest income is recognized on the accrual basis and
includes the amortization of premium or discount on fixed interest
securities purchased at amounts different from their par value.
Gains and losses on investments are included in income when
realized. Investments are recorded on a trade date basis and the
cost of securities sold is determined on the first-in, first-out
basis.
Investments are reviewed periodically to determine if they have
sustained an impairment of value that is considered to be other than
temporary. The identification of potentially impaired investments
involves significant management judgment, which includes the
determination of their fair value and the assessment of whether any
decline in value is other than temporary. If investments are
determined to be impaired, a loss is charged to income in that
period.
(g) FOREIGN CURRENCY
Monetary assets and liabilities denominated in foreign currencies
have been translated to U.S. dollars at the rates of exchange
prevailing at the balance sheet date. Income and expense
transactions originating in foreign currencies are translated at the
rates of exchange prevailing on the date of the transaction. Gains
and losses on foreign currency translation are included in income.
(3)
OLYMPUS RE HOLDINGS, LTD.
Notes to Consolidated Financial Statements
FOR THE YEAR ENDED DECEMBER 31, 2005
--------------------------------------------------------------------------------
(expressed in U.S. dollars)
3. LOSS AND LOSS ADJUSTMENT EXPENSE RESERVES
Loss and loss adjustment expense reserves are estimates subject to
variability, and the variability could be material in the near term. The
variability arises because all events affecting the ultimate settlement of
claims have not taken place and may not take place for some time.
Variability can be caused by receipt of additional claim information,
changes in judicial interpretation of contracts or significant changes in
the severity or frequency of claims from historical trends. Loss and loss
adjustment expenses estimates are based on all relevant information
available to the Company. Methods of estimation are used which the Company
believes produce reasonable results given current information.
Reserve activity for loss and loss expenses is summarized below:
$
BALANCE - BEGINNING OF YEAR 301,021,728
-------------
Net claims and claims expenses incurred
for the year related to:
Current year 987,678,228
Prior year 38,652,875
-------------
1,026,331,103
-------------
Net paid claims and claims expenses
for the year related to:
Current year 89,881,651
Prior year 211,477,398
-------------
301,359,049
-------------
BALANCE - END OF YEAR 1,025,993,782
=============
(4)
OLYMPUS RE HOLDINGS, LTD.
Notes to Consolidated Financial Statements
FOR THE YEAR ENDED DECEMBER 31, 2005
--------------------------------------------------------------------------------
(expressed in U.S. dollars)
The Company suffered significant catastrophe losses during 2005 (see note
4). In addition, during 2005 there was adverse development of $41.6
million on the loss and loss adjustment expense reserves for hurricanes
and typhoons recorded during 2004. The majority of this development was
for marine and energy claims from hurricane Ivan, which were reported for
the first time in 2005.
The December 31, 2005 year end balance is comprised of provisions for
reported claims of $676,149,004 and provisions for claims incurred but not
reported of $349,844,778.
4. 2005 CATASTROPHE LOSSES
The Company suffered significant losses from the catastrophe events which
occurred in 2005, the largest of which were the losses from Hurricanes
Katrina, Rita and Wilma. The net impact to the Company was:
--------------------------------------------------------------------------
KATRINA RITA WILMA
--------------------------------------------------------------------------
Gross losses incurred $ 714,915,375 $ 72,374,829 $ 67,047,264
--------------------------------------------------------------------------
Reinstatement premiums earned (77,673,277) (4,357,371) (2,791,635)
--------------------------------------------------------------------------
Override commission, brokerage
& FET 10,872,548 541,295 356,162
--------------------------------------------------------------------------
NET IMPACT 648,114,646 68,558,753 64,611,791
--------------------------------------------------------------------------
The Company's estimates for these losses are based on currently available
information from cedants and actual losses may vary from these estimates
due to the inherent uncertainties in reserving for such losses, and these
variances could be material. 77% of the Company's loss and loss adjustment
expense reserves as at December 31, 2005 were for these three Hurricanes.
5. MAJOR CUSTOMERS
During the year ended December 31, 2005, the Company derived 75% of its
premiums written from Folksamerica Reinsurance Company ("Folksamerica")
for which the Company pays an override commission. During the year ended
December 31, 2005, the Company derived 11% of its premiums written from
business recommended by White Mountains Underwriting for which the Company
pays an override commission. During the year ended December 31, 2005 the
Company derived 13% of its premiums written from Sirius International
Insurance Corporation("Sirius") for which the Company pays an override
commission. Folksamerica, White Mountains Underwriting and Sirius are
wholly-owned subsidiaries of White Mountains Insurance Group Ltd. ("White
Mountains"), parent of White Mountain Advisors, LLC. White Mountains has
an approximate 0.01% indirect ownership in the Company. Included in
premiums receivable for the year ended December 31, 2005 was an amount of
$148,335,494, due from Folksamerica and $31,444,740 from Sirius.
(5)
OLYMPUS RE HOLDINGS, LTD.
Notes to Consolidated Financial Statements
FOR THE YEAR ENDED DECEMBER 31, 2005
--------------------------------------------------------------------------------
(expressed in U.S. dollars)
6. TAXATION
BERMUDA
The Company has received an undertaking from the Bermuda government
exempting it from all local income, withholding and capital gains taxes
until March 28, 2016. At the present time no such taxes are levied in
Bermuda.
UNITED STATES
The Company does not consider itself to be engaged in trade or business in
the United States and, accordingly, does not expect to be subject to
United States income tax.
7. STATUTORY REQUIREMENTS
Under The Act, Olympus Re is required to prepare Statutory Financial
Statements and to file a Statutory Financial Return. The Act also requires
Olympus Re to maintain a minimum share capital of $1,000,000 and to meet a
minimum solvency margin equal to the greater of $100,000,000, 50% of net
premiums written or 15% of the loss and loss adjustment expense reserves.
Olympus Re did not meet the minimum solvency margin at December 31, 2005.
Statutory capital and surplus as reported under The Act is different from
shareholders' equity as determined in conformity with accounting
principles generally accepted in the United States of America ("GAAP") due
to certain items that are capitalized under GAAP but expensed under The
Act.
Olympus Re is also required to maintain a minimum liquidity ratio under
the Act, which was met for the year ended December 31, 2005.
(6)
OLYMPUS RE HOLDINGS, LTD.
Notes to Consolidated Financial Statements
FOR THE YEAR ENDED DECEMBER 31, 2005
--------------------------------------------------------------------------------
(expressed in U.S. dollars)
The Company reported the statutory non-compliance to the Bermuda Monetary
Authority ("BMA") and met with them to discuss plans to return to
compliance. Olympus Re returned to compliance under The Act in January
2006 following the completion of the capital raise (see note 11). The BMA
has restricted Olympus Re's license with effect from January 1, 2006 to
only write the quota share treaties with Folksamerica.
8. CAPITAL RAISING ACTIVITIES
During late 2005 and early 2006 the Company conducted a capital raise
through concurrent private placement memoranda (the "Memoranda"). The
Memoranda allowed potential investors the choice of investing in the
operations of the Company and/or Helicon. Helicon's operations involve the
participation, through Helicon Re, in the quota share business with
Folksamerica on similar terms as Olympus Re.
The Company received $32,740,242 in subscriptions in respect of the
capital raise prior to December 31, 2005. In addition the Company has
incurred expenses of $1,434,635 for the year ended December 31, 2005 in
respect of the capital raise and has deferred these. They will be offset
against the proceeds of the capital raise in 2006.
The capital raise closed in January 2006. The Company raised a total of
$156,500,000 for the operations of Olympus Re and an additional
$145,500,000 was raised for the operations of Helicon Re. At the date of
the closing Helicon repurchased its own shares from the Company and
consequently as of that date its results are no longer consolidated by
Olympus Re Holdings, Ltd.
The capital raise resulted in 8.5 million new shares issued by the Company
during January 2006 with an additional 17.5 million shares to be issued
promptly following the release of the audited financial statements for the
year ended December 31, 2005.
As part of the capital raise process of the Company, White Mountains
Underwriting has consented to an arrangement whereby Helicon Re may use
portions of Olympus Re's profit commission deficit (see note 6) to settle
profit commissions which would otherwise be payable by Helicon Re to White
Mountains Underwriting. This is accomplished by an agreement whereby
Helicon Re must annually purchase for cash from Olympus Re, at book value,
the amount of the profit commission deficit that Helicon Re can use in any
given year to settle its own profit commission payable to White Mountains
Underwriting. This arrangement will remain in place until all of Olympus
Re's profit commission deficit as of December 31, 2005 is utilized.
9. SUBSEQUENT EVENTS (UNAUDITED)
During 2006 the Company experienced adverse loss development on the 2005
hurricane losses of $249 million. The majority of this development was for
marine and energy claims from Hurricanes Katrina and Rita.
The Company has entered into an Indemnity Agreement with Folksamerica
Holdings Company Inc. (Folksamerica Holdings) under which it will be
reimbursed for up to $137 million of losses with dates of loss of December
31, 2005 and prior to the extent that they exceed the losses reflected on
Olympus Re's balance sheet as of March 31, 2006. Olympus Re expects to
recover the full $137 million. In addition, the Agreement provides that
Folksamerica Holdings will reimburse Olympus Re for all override
commissions earned by Folksamerica and White Mountains Underwriting after
March 31, 2006 in respect of business incepting prior to December 31,
2005.
(7)
EAGLEROCK CAPITAL
PARTNERS (QP), LP
FINANCIAL STATEMENTS
THREE YEARS ENDED DECEMBER 31, 2007
EAGLEROCK CAPITAL
PARTNERS (QP), LP
================================================================================
FINANCIAL STATEMENTS
THREE YEARS ENDED DECEMBER 31, 2007
1
EAGLEROCK CAPITAL PARTNERS (QP), LP
CONTENTS
================================================================================
EAGLEROCK CAPITAL PARTNERS (QP), LP
INDEPENDENT AUDITORS' REPORT 3
FINANCIAL STATEMENTS:
Statements of assets and liabilities 4
Statements of operations 5
Statements of changes in partners' capital 6
Statements of changes in net assets 7
Summary of business and significant accounting policies 8-9
Notes to financial statements 10-12
EAGLEROCK MASTER FUND, LP 13
INDEPENDENT AUDITORS' REPORT 14
FINANCIAL STATEMENTS:
Statements of assets and liabilities 15
Condensed schedule of investments - December 31, 2007 16-22
Condensed schedule of investments - December 31, 2006 23-30
Statements of operations 31
Statements of changes in partners' capital 32
Statements of changes in net assets 33
Summary of business and significant accounting policies 34-38
Notes to financial statements 39-42
2
INDEPENDENT AUDITORS' REPORT
The Partners
EagleRock Capital Partners (QP), LP
New York, New York
We have audited the accompanying statements of assets and liabilities of
EagleRock Capital Partners (QP), LP ("Partnership") as of December 31, 2007 and
2006, and the related statements of operations, changes in partners' capital,
and changes in net assets for each of the three years in the period ended
December 31, 2007. These financial statements are the responsibility of the
Partnership's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes consideration of
internal control over financial reporting as a basis for designing audit
procedures that are appropriate in the circumstances, but not for the purpose of
expressing an opinion on the effectiveness of the Partnership's internal control
over financial reporting. Accordingly, we express no such opinion. An audit also
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by management, as well
as evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of EagleRock Capital Partners
(QP), LP as of December 31, 2007 and 2006, and the results of its operations,
changes in partners' capital and its changes in net assets for each of the three
years in the period ended December 31, 2007, in conformity with accounting
principles generally accepted in the United States of America.
/s/ BDO Seidman, LLP
New York, NY
March 7, 2008
3
EAGLEROCK CAPITAL PARTNERS (QP), LP
STATEMENTS OF ASSETS AND LIABILITIES
================================================================================
December 31, 2007 2006
---------------------------------------------------------- ----------------- ------------------
ASSETS
Investment in EagleRock Master Fund, LP $35,532,472 $72,577,210
Receivable from EagleRock Master Fund (Note 3) 7,000,000 9,920,929
Cash - 556
Prepaid and other assets (Note 2) - 62,088
---------------------------------------------------------- ----------------- ------------------
42,532,472 82,560,783
LIABILITIES
Capital withdrawals payable (Note 3) 7,000,000 9,920,929
---------------------------------------------------------- ----------------- ------------------
CONTINGENCY (NOTE 4)
NET ASSETS (PARTNERS' CAPITAL) (NOTE 3) $35,532,472 $72,639,854
========================================================== ================= ==================
See accompanying summary of business and significant accounting policies
and notes to financial statements.
4
EAGLEROCK CAPITAL PARTNERS (QP), LP
STATEMENTS OF OPERATIONS
================================================================================
Year ended December 31, 2007 2006 2005
------------------------------------------------------ -------------------- -------------------- --------------------
INVESTMENT INCOME (LOSS):
Net investment income (loss) allocated
from EagleRock Master Fund, LP:
Interest $ 2,212,674 $ 2,319,940 $ 7,019,216
Dividends, net 734,883 1,387,290 942,273
Other income, net 1,308,779 - -
Expenses (4,151,026) (5,893,716) (10,675,122)
------------------------------------------------------ -------------------- -------------------- --------------------
NET INVESTMENT INCOME (LOSS) FROM 105,310 (2,186,486) (2,713,633)
EAGLEROCK MASTER FUND, LP
------------------------------------------------------ -------------------- -------------------- --------------------
EXPENSES:
Management fees (Note 2) 517,803 776,100 1,501,405
Other 365 4,400 4,400
------------------------------------------------------ -------------------- -------------------- --------------------
TOTAL EXPENSES 518,168 780,500 1,505,805
------------------------------------------------------ -------------------- -------------------- --------------------
NET INVESTMENT LOSS (412,858) (2,966,986) (4,219,438)
REALIZED AND UNREALIZED GAIN ON INVESTMENTS
ALLOCATED FROM EAGLEROCK MASTER FUND, LP:
Net realized gain on investments 17,619,438 6,794,278 6,012,886
Net change in unrealized gain on investments (32,313,962) 18,514,492 (40,395,693)
------------------------------------------------------ -------------------- -------------------- --------------------
NET INCOME (LOSS) (NOTE 1) $(15,107,382) $22,341,784 $(38,602,245)
====================================================== ==================== ==================== ====================
See accompanying summary of business and significant accounting policies
and notes to financial statements.
5
EAGLEROCK CAPITAL PARTNERS (QP), LP
STATEMENTS OF CHANGES IN PARTNERS' CAPITAL
================================================================================
Three years ended December 31, 2007
------------------------------------------------ ---------------------- ---------------------- ----------------------
General Limited
partner partners Total
------------------------------------------------ ---------------------- ---------------------- ----------------------
BALANCE, JANUARY 1, 2005 $12,552,896 $148,993,439 $161,546,335
Capital withdrawals - (1,805,269) (1,805,269)
Net loss (Note 1):
Pro rata allocation (2,896,764) (35,705,481) (38,602,245)
------------------------------------------------ ---------------------- ---------------------- ----------------------
BALANCE, DECEMBER 31, 2005 9,656,132 111,482,689 121,138,821
Capital withdrawals - (70,840,751) (70,840,751)
Net income (Note 1):
Pro rata allocation 2,637,109 19,704,675 22,341,784
Profit participation allocation (5,061) 5,061 -
------------------------------------------------ ---------------------- ---------------------- ----------------------
BALANCE, DECEMBER 31, 2006 12,288,180 60,351,674 72,639,854
Capital withdrawals - (22,000,000) (22,000,000)
Net loss (Note 1):
Pro rata allocation (3,443,838) (11,663,544) (15,107,382)
Performance allocation 158,116 (158,116) -
Profit participation allocation (1,130) 1,130 -
------------------------------------------------ ---------------------- ---------------------- ----------------------
BALANCE, DECEMBER 31, 2007 $ 9,001,328 $ 26,531,144 $ 35,532,472
================================================ ====================== ====================== ======================
See accompanying summary of business and significant accounting policies
and notes to financial statements.
6
EAGLEROCK CAPITAL PARTNERS (QP), LP
STATEMENTS OF CHANGES IN NET ASSETS
================================================================================
Year ended December 31, 2007 2006 2005
------------------------------------------------------ -------------------- -------------------- --------------------
INCREASE (DECREASE) IN NET ASSETS FROM OPERATIONS:
Net investment loss $ (412,858) $ (2,966,986) $ (4,219,438)
Net realized gain on investments 17,619,438 6,794,278 6,012,886
Net change in unrealized gain on investments (32,313,962) 18,514,492 (40,395,693)
------------------------------------------------------ -------------------- -------------------- --------------------
NET INCREASE (DECREASE) IN NET ASSETS
RESULTING FROM OPERATIONS (15,107,382) 22,341,784 (38,602,245)
DECREASE IN NET ASSETS FROM CAPITAL TRANSACTIONS:
Capital withdrawals (15,000,000) (60,919,822) -
Capital withdrawals payable (7,000,000) (9,920,929) (1,805,269)
------------------------------------------------------ -------------------- -------------------- --------------------
TOTAL DECREASE (37,107,382) (48,498,967) (40,407,514)
NET ASSETS, BEGINNING OF YEAR 72,639,854 121,138,821 161,546,335
------------------------------------------------------ -------------------- -------------------- --------------------
NET ASSETS, END OF YEAR $ 35,532,472 $ 72,639,854 $121,138,821
====================================================== ==================== ==================== ====================
See accompanying summary of business and significant accounting policies
and notes to financial statements.
7
EAGLEROCK CAPITAL PARTNERS (QP), LP
SUMMARY OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
================================================================================
BUSINESS EagleRock Capital Partners (QP), L.P.
("Partnership") is a Delaware limited
partnership organized to invest and trade
in securities and other investment
vehicles and instruments. The Partnership
invests the majority of its assets in
EagleRock Master Fund, LP ("Master
Fund"). The Partnership is also a general
partner in the Master Fund. Mariel
Capital Management, LLC ("General
Partner") is the general partner of the
Partnership. The financial statements of
the Master Fund are included elsewhere in
this report and should be read with the
Partnership's financial statements.
SIGNIFICANT ACCOUNTING POLICIES Investment in EagleRock Master Fund, LP
The investment in the Master Fund is fair
valued at the Partnership's proportionate
interest in the net assets and net income
(loss) of the Master Fund. Valuation of
the investments held by the Master Fund is
discussed in the notes to the Master Fund
financial statements included elsewhere in
this report. The percentage of the Master
Fund partners' capital owned by the
Partnership at December 31, 2007 and 2006
was approximately 68% and 81%,
respectively.
Investment Transactions
The Partnership records all security
transactions and related expenses on a
trade date basis. Revenues and expenses
are recorded on the accrual basis.
Dividends are recorded on the ex-dividend
date and interest is accrued in the
period earned.
Income Taxes
No income tax provision has been made in
the accompanying financial statements
since the partners are required to report
their respective shares of the Partnership
income in their individual income tax
returns.
8
EAGLEROCK CAPITAL PARTNERS (QP), LP
SUMMARY OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
================================================================================
In July 2006, the Financial Accounting
Standards Board (the "FASB") issued FASB
Interpretation No. 48 ("FIN 48"),
"Accounting for Uncertainty in Income
Taxes", which establishes that a tax
position taken or expected to be taken in
a tax return is to be recognized in the
financial statements when it is more
likely than not, based on the technical
merits, that the position will be
sustained upon examination. FIN 48 is
effective for fiscal years beginning after
December 15, 2007. The adoption of FIN 48
did not have a material impact on the
Partnership's results of operations or its
financial position.
Use of Estimates
The preparation of financial statements in
conformity with accounting principles
generally accepted in the United States of
America requires management to make
estimates and assumptions that affect the
reported amounts of assets and liabilities
and disclosure of contingent assets and
liabilities at the date of the financial
statements and the reported amounts of
revenues and expenses during the year.
Actual results could differ from those
estimates.
New Accounting Pronouncement
In September 2006, the FASB issued
Statement of Financial Accounting
Standards ("SFAS") No. 157, "Fair Value
Measurements". This standard clarifies the
definition of fair value for financial
reporting, establishes a framework for
measuring fair value and requires
additional disclosures about the use of
fair value measurements. SFAS No. 157 is
effective for financial statements issued
for fiscal years beginning after November
15, 2007 and interim periods within those
fiscal years. As of December 31, 2007, the
Partnership does not believe the adoption
of SFAS No. 157 will impact the amounts
reported in the financial statements.
However, additional disclosures will be
required about the inputs used to develop
the measurements of fair value and the
effect of certain of the measurements
reported in the statement of operations
for a fiscal year.
9
EAGLEROCK CAPITAL PARTNERS (QP), LP
NOTES TO FINANCIAL STATEMENTS
================================================================================
1. ALLOCATION OF NET INCOME The net income (loss) for the three years
(LOSS), PERFORMANCE ended December 31, 2007 is allocated to
ALLOCATION AND PROFIT each partner in accordance with the ratio
PARTICIPATION ALLOCATION of the capital account of each partner to
the total of all capital accounts at the
beginning of each fiscal period.
At the end of each performance period, 10%
of net income in excess of cumulative loss
is reallocated to the capital accounts of
the General Partner as a performance
allocation. For capital withdrawals made
during a performance period, a performance
allocation of 10% of net income in excess
of cumulative loss is reallocated on a pro
rata basis to the General Partner. The
General Partner may, at its discretion,
waive or alter this allocation. For the
year ended December 31, 2007, the
performance allocation was $158,116. There
was no performance allocation for the
years ended December 31, 2006 and 2005.
In consideration of one of the limited
partner's contribution, the limited
partner is entitled to receive 10% of any
performance allocation paid to the General
Partner by an affiliated partnership (the
"Profit Participation Allocation"). The
General Partner may, at its discretion,
increase this fee. For the years ended
December 31, 2007, 2006 and 2005, Profit
Participation Allocation earned from the
affiliated partnership was $1,130, $5,061
and $-0-, respectively.
10
EAGLEROCK CAPITAL PARTNERS (QP), LP
NOTES TO FINANCIAL STATEMENTS
================================================================================
2. MANAGEMENT FEE EagleRock Capital Management, LLC
("Investment Manager") serves as the
Investment Manager of the Partnership.
The Partnership incurs a quarterly fee
payable at the beginning of each quarter
equal to .375% (1.50% per annum) of the
capital account balance of each limited
partner as of the close of the preceding
quarter. The General Partner may, at its
discretion, reduce or eliminate this fee.
Management fees are paid by the Master
Fund and reimbursed by the Partnership.
For one of the limited partners of the
Partnership, a separate agreement exists
stating that the Partnership incur a
quarterly fee payable at the beginning of
each quarter equal to .25% (1.00% per
annum) of the capital account balance of
the limited partner as of the close of
the preceding quarter. For the years
ended December 31, 2007, 2006 and 2005,
the Partnership's management fees were
$517,803, $766,100 and $1,501,405,
respectively. At December 31, 2006, the
Partnership made an advanced payment of
$61,723 to the Investment Manager, which
is included in prepaid and other assets
and was applied to the 2007 management
fees.
3. CAPITAL TRANSACTIONS Capital Withdrawals Payable
As of December 31, 2007, the Partnership
had a receivable from the Master Fund of
$7,000,000 with respect to capital
withdrawals payable to its limited
partner. As of March 7, 2008, the
Partnership made payments for such capital
withdrawals totaling $7,000,000.
As of December 31, 2006, the Partnership
had a receivable from the Master Fund of
$9,920,929 with respect to capital
withdrawals payable to its limited
partners. During 2007, the Partnership
made payments for such capital
withdrawals.
Subsequent Capital Transactions
From January 1, 2008 to March 7, 2008, the
Partnership made payments for capital
withdrawals totaling $7,000,000 (see
above). There were no capital
contributions or withdrawals in the same
period.
11
EAGLEROCK CAPITAL PARTNERS (QP), LP
NOTES TO FINANCIAL STATEMENTS
================================================================================
4. CONTINGENCY From time to time, the
Partnership and its affiliates receive
inquiries from regulatory agencies. The
Partnership and its affiliates fully
cooperate with such inquiries. It is not
possible to predict the outcome of such
inquiries.
5. FINANCIAL HIGHLIGHTS The financial
highlights represent the Partnership's
financial performance for the three years
ended December 31, 2007.
An individual partner's performance may
vary based on different financial
arrangements such as management fee,
performance allocation, and the timing of
capital transactions.
Total return is computed based on the
change in a limited partner capital
account during the year, adjusted for
capital contributions and withdrawals.
The operating expense and net investment
loss ratios do not reflect the effect of
the performance and profit participation
allocation.
Limited partner 2007 2006 2005
-------------------------------------- ------------- ------------- -------------
Total return before performance (28.28)% 26.09% (23.96)%
allocation
Performance allocation net of profit
participation allocation (.37) - -
-------------------------------------- ------------- ------------- -------------
Total return after
performance and profit
participation allocation (28.65)% 26.09% (23.96)%
====================================== ============= ============= =============
PERCENTAGES TO AVERAGE NET ASSETS:
Operating expense ratio 7.80% 7.50% 8.54%
Performance allocation net of
profit participation allocation .32 - -
-------------------------------------- ------------- ------------- -------------
Total expenses and
performance and profit
participation allocation 8.12% 7.50% 8.54%
-------------------------------------- ------------- ------------- -------------
Net investment loss ratio (.90)% (3.40)% (3.02)%
====================================== ============= ============= =============
12
EAGLEROCK MASTER FUND, LP
================================================================================
FINANCIAL STATEMENTS
THREE YEARS ENDED DECEMBER 31, 2007
13
INDEPENDENT AUDITORS' REPORT
The Partners
EagleRock Master Fund, LP
Grand Cayman, Cayman Islands
We have audited the accompanying statements of assets and liabilities, including
the condensed schedules of investments, of EagleRock Master Fund LP as of
December 31, 2007 and 2006, and the related statements of operations, changes in
partners' capital, and changes in net assets for each of the three years in the
period ended December 31, 2007. These financial statements are the
responsibility of the Partnership's management. Our responsibility is to express
an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes consideration of
internal control over financial reporting as a basis for designing audit
procedures that are appropriate in the circumstances, but not for the purpose of
expressing an opinion on the effectiveness of the Partnership internal control
over financial reporting. Accordingly, we express no such opinion. An audit also
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by management, as well
as evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of EagleRock Master Fund LP as of
December 31, 2007 and 2006, and the results of its operations, changes in
partners' capital and changes in net assets for each of the three years in the
period ended December 31, 2007, in conformity with accounting principles
generally accepted in the United States of America.
/s/ BDO Seidman, LLP
New York, NY
March 7, 2008
14
EAGLEROCK MASTER FUND, LP
STATEMENTS OF ASSETS AND LIABILITIES
(EXPRESSED IN US DOLLARS)
=============================================== ================ ================= ================ =================
December 31, 2007 2006
----------------------------------------------- ---------------- ----------------- ---------------- -----------------
ASSETS
Investments in securities at market or fair
value (cost $80,334,473 and $163,830,864)
(Notes 1, 4 and 5):
Securities (cost $73,666,632 and
$153,334,832) $88,273,496 $214,117,270
Securities pledged to counterparty
(cost $6,667,841 and $10,496,032) 7,043,107 $95,316,603 10,498,542 $224,615,812
---------------- ----------------
Due from brokers, net (Notes 1 and 5) 3,323,920 5,375,542
Unrealized gain on open swap contracts
(Notes 1 and 5) 351,528 -
Dividends and interest receivable 136,768 1,040,896
----------------------------------------------- ---------------- ----------------- ---------------- -----------------
99,128,819 231,032,250
----------------------------------------------- ---------------- ----------------- ---------------- -----------------
LIABILITIES
Securities sold, not yet purchased, at market
or fair value (proceeds $37,261,164 and
$97,748,620)
(Notes 1, 4 and 5) 37,704,690 99,003,941
Unrealized loss on open swap contracts
(Notes 1 and 5) - 1,309,844
Capital withdrawals payable to feeder funds
(Note 6) 8,774,092 38,892,082
Dividends and interest payable 321,703 1,828,639
Accrued expenses 46,256 20,000
----------------------------------------------- ---------------- ----------------- ---------------- -----------------
46,846,741 141,054,506
----------------------------------------------- ---------------- ----------------- ---------------- -----------------
CONTINGENCIES (NOTE 7)
NET ASSETS (PARTNERS' CAPITAL) (NOTE 6) $52,282,078 $ 89,977,744
=============================================== ================ ================= ================ =================
See accompanying summary of business and significant accounting policies
and notes to financial statements.
15
EAGLEROCK MASTER FUND, LP
CONDENSED SCHEDULE OF INVESTMENTS
(EXPRESSED IN US DOLLARS)
=========================================================================== ==================== ====================
December 31, 2007
------------------ -------------------------------------------------------- -------------------- --------------------
Number of % of net assets Market or
shares/face value Description of $52,282,078 fair value
------------------ -------------------------------------------------------- -------------------- --------------------
INVESTMENTS IN SECURITIES:
Common stock:
United States:
Automotive .62% $ 325,462
Building materials 4.34 2,269,120
Business services 9.12 4,768,615
Capital equipment 2.28 1,189,994
Chemicals 1.55 811,659
Computers .19 100,894
Consumer products 5.76 3,009,827
Electronics 6.76 3,533,758
Energy 8.39 4,384,318
Financial services 6.39 3,341,064
Food processing:
845,786 Darling International Inc. 18.70 9,777,286
Other 1.49 779,594
Healthcare 4.26 2,229,719
Index .10 50,050
Media, entertainment and leisure 6.76 3,534,863
Mining and metals:
241,688 WCI Steel Inc. 10.17 5,317,136
Other 2.97 1,551,193
Packaging and containers:
1,680,115 Constar International Inc. 13.11 6,854,869
Paper and paper products 1.10 577,093
Pharmaceuticals and biotechnology .20 104,622
Products and services 2.47 1,289,533
Retail 4.06 2,120,279
Semiconductors 1.26 656,347
Software 4.54 2,375,140
Telecommunications 5.15 2,692,660
Transportation 2.80 1,463,859
Utilities .96 506,619
------------------ -------------------------------------------------------- -------------------- --------------------
TOTAL COMMON STOCK - UNITED STATES 125.50 65,615,573
(COST $53,595,895)
------------------ -------------------------------------------------------- -------------------- --------------------
=========================================================================== ==================== ====================
See accompanying summary of business and significant accounting policies
and notes to financial statements.
16
EAGLEROCK MASTER FUND, LP
CONDENSED SCHEDULE OF INVESTMENTS
(EXPRESSED IN US DOLLARS)
=========================================================================== ==================== ====================
December 31, 2007
--------------------------------------------------------------------------- -------------------- --------------------
Number of Description % of net assets Market or
shares/face value of $52,282,078 fair value
------------------ -------------------------------------------------------- -------------------- --------------------
INVESTMENTS IN SECURITIES (CONTINUED):
Common stock (continued):
Bermuda:
Financial services .62% $ 321,877
Media, entertainment and leisure 1.49 780,661
------------------ -------------------------------------------------------- -------------------- --------------------
TOTAL COMMON STOCK - BERMUDA 2.11 1,102,538
(COST $1,131,706)
------------------ -------------------------------------------------------- -------------------- --------------------
Canada:
Mining and metals 1.12 584,922
Transportation .12 60,388
------------------ -------------------------------------------------------- -------------------- --------------------
TOTAL COMMON STOCK - CANADA 1.24 645,310
(COST $557,080)
------------------ -------------------------------------------------------- -------------------- --------------------
Germany:
Financial services .12 65,000
------------------ -------------------------------------------------------- -------------------- --------------------
TOTAL COMMON STOCK - GERMANY .12 65,000
(COST $329,567)
------------------ -------------------------------------------------------- -------------------- --------------------
Hong Kong:
Financial services .30 155,129
------------------ -------------------------------------------------------- -------------------- --------------------
TOTAL COMMON STOCK - HONG KONG .30 155,129
(COST $220,896)
------------------ -------------------------------------------------------- -------------------- --------------------
Italy:
Food processing .11 57,094
------------------ -------------------------------------------------------- -------------------- --------------------
TOTAL COMMON STOCK - ITALY (COST $57,295) .11 57,094
------------------ -------------------------------------------------------- -------------------- --------------------
Korea:
Semiconductors .06 30,636
------------------ -------------------------------------------------------- -------------------- --------------------
TOTAL COMMON STOCK - KOREA (COST $58,910) .06 30,636
------------------ -------------------------------------------------------- -------------------- --------------------
Mexico:
Media, entertainment and leisure .34 178,275
------------------ -------------------------------------------------------- -------------------- --------------------
TOTAL COMMON STOCK - MEXICO .34 178,275
(COST $180,979)
------------------ -------------------------------------------------------- -------------------- --------------------
=========================================================================== ==================== ====================
See accompanying summary of business and significant accounting policies
and notes to financial statements.
17
EAGLEROCK MASTER FUND, LP
CONDENSED SCHEDULE OF INVESTMENTS
(EXPRESSED IN US DOLLARS)
=========================================================================== ==================== ====================
December 31, 2007
--------------------------------------------------------------------------- -------------------- --------------------
Number of Description % of net assets Market or
shares/face value of $52,282,078 fair value
------------------ -------------------------------------------------------- -------------------- --------------------
INVESTMENTS IN SECURITIES (CONTINUED):
Common stock (continued):
Norway:
Transportation 2.15% $ 1,124,624
------------------ -------------------------------------------------------- -------------------- --------------------
TOTAL COMMON STOCK - NORWAY 2.15 1,124,624
(COST $1,046,960)
------------------ -------------------------------------------------------- -------------------- --------------------
Singapore:
Semiconductors .46 241,200
------------------ -------------------------------------------------------- -------------------- --------------------
TOTAL COMMON STOCK - SINGAPORE .46 241,200
(COST $243,624)
------------------ -------------------------------------------------------- -------------------- --------------------
South Africa:
Mining and metals 1.25 653,200
------------------ -------------------------------------------------------- -------------------- --------------------
TOTAL COMMON STOCK - SOUTH AFRICA 1.25 653,200
(COST $659,580)
------------------ -------------------------------------------------------- -------------------- --------------------
Taiwan:
Semiconductors .23 120,674
------------------ -------------------------------------------------------- -------------------- --------------------
TOTAL COMMON STOCK - TAIWAN .23 120,674
(COST $104,256)
------------------ -------------------------------------------------------- -------------------- --------------------
United Arab Emirates:
Transportation .40 208,240
------------------ -------------------------------------------------------- -------------------- --------------------
TOTAL COMMON STOCK - UNITED ARAB .40 208,240
EMIRATES (COST $197,600)
------------------ -------------------------------------------------------- -------------------- --------------------
TOTAL COMMON STOCK (COST $58,384,348) 134.27 70,197,493
------------------ -------------------------------------------------------- -------------------- --------------------
=========================================================================== ==================== ====================
See accompanying summary of business and significant accounting policies
and notes to financial statements.
18
EAGLEROCK MASTER FUND, LP
CONDENSED SCHEDULE OF INVESTMENTS
(EXPRESSED IN US DOLLARS)
=========================================================================== ==================== ====================
December 31, 2007
--------------------------------------------------------------------------- -------------------- --------------------
Number of Description % of net assets Market or
shares/face value of $52,282,078 fair value
------------------ -------------------------------------------------------- -------------------- --------------------
INVESTMENTS IN SECURITIES (CONTINUED):
Long-term debt securities:
United States:
Automotive .52% $ 271,800
Business services .64 336,364
Chemicals 1.25 656,000
Energy 3.06 1,601,515
Food processing .57 296,563
Media, entertainment and leisure 1.38 722,412
Mining and metals .05 27,633
Transportation .36 187,000
------------------ -------------------------------------------------------- -------------------- --------------------
TOTAL LONG-TERM DEBT SECURITIES - UNITED 7.83 4,099,287
STATES (COST $8,260,719)
------------------ -------------------------------------------------------- -------------------- --------------------
Bermuda:
Telecommunications .90 469,500
------------------ -------------------------------------------------------- -------------------- --------------------
TOTAL LONG-TERM DEBT SECURITIES - .90 469,500
BERMUDA (COST $-0-)
------------------ -------------------------------------------------------- -------------------- --------------------
United Kingdom:
Packaging and containers .53 275,000
------------------ -------------------------------------------------------- -------------------- --------------------
TOTAL LONG-TERM DEBT SECURITIES - UNITED .53 275,000
KINGDOM (COST $178,856)
------------------ -------------------------------------------------------- -------------------- --------------------
TOTAL LONG-TERM DEBT SECURITIES
(COST $8,439,575) 9.26 4,843,787
------------------ -------------------------------------------------------- -------------------- --------------------
Preferred stock:
United States:
Automotive .08 40,875
Financial services 1.12 586,001
Mining and metals:
350,281 WCI Steel, Inc. 17.69 9,247,418
------------------ -------------------------------------------------------- -------------------- --------------------
TOTAL PREFERRED STOCK (COST $3,967,183) 18.89 9,874,294
------------------ -------------------------------------------------------- -------------------- --------------------
Options purchased:
United States 19.89 10,401,029
------------------ -------------------------------------------------------- -------------------- --------------------
TOTAL OPTIONS PURCHASED
(COST $9,543,367) 19.89 10,401,029
------------------ -------------------------------------------------------- -------------------- --------------------
TOTAL INVESTMENTS IN SECURITIES
(COST $80,334,473) 182.31% $95,316,603
------------------ -------------------------------------------------------- -------------------- --------------------
UNREALIZED GAIN ON OPEN SWAP CONTRACTS:
Credit default swaps: .67% $ 351,528
------------------ -------------------------------------------------------- -------------------- --------------------
TOTAL UNREALIZED GAIN ON OPEN SWAP
CONTRACTS .67% $ 351,528
------------------ -------------------------------------------------------- -------------------- --------------------
=========================================================================== ==================== ====================
See accompanying summary of business and significant accounting policies
and notes to financial statements.
19
EAGLEROCK MASTER FUND, LP
CONDENSED SCHEDULE OF INVESTMENTS
(EXPRESSED IN US DOLLARS)
=========================================================================== ==================== ====================
December 31, 2007
--------------------------------------------------------------------------- -------------------- --------------------
Number of Description % of net assets Market or
shares/face value of $52,282,078 fair value
------------------ -------------------------------------------------------- -------------------- --------------------
SECURITIES SOLD, NOT YET PURCHASED:
Common stock:
United States:
Automotive .31% $ 159,668
Building materials .04 20,340
Business services .57 298,130
Capital equipment 2.15 1,124,134
Chemicals:
252,200 Solutia Inc. 9.94 5,195,320
Other .09 47,974
Computers .03 18,250
Consumer products 3.13 1,636,118
Energy .01 7,561
Financial services 3.82 1,996,182
Food processing .07 36,546
Healthcare .27 140,970
Index .03 15,044
Media, entertainment and leisure -- 292
Packaging and containers .05 25,361
Paper and paper products .04 20,621
Pharmaceutical and biotechnology .81 425,497
Products and services .11 58,080
Residential construction .07 36,329
Retail 3.04 1,587,456
Software .13 67,544
Telecommunications .54 280,363
------------------ -------------------------------------------------------- -------------------- --------------------
TOTAL COMMON STOCK - UNITED STATES 25.25 13,197,780
(PROCEEDS $13,005,031)
------------------ -------------------------------------------------------- -------------------- --------------------
=========================================================================== ==================== ====================
See accompanying summary of business and significant accounting policies
and notes to financial statements.
20
EAGLEROCK MASTER FUND, LP
CONDENSED SCHEDULE OF INVESTMENTS
(EXPRESSED IN US DOLLARS)
=========================================================================== ==================== ====================
December 31, 2007
--------------------------------------------------------------------------- -------------------- --------------------
Number of Description % of net assets Market or
shares/face value of $52,282,078 fair value
------------------ -------------------------------------------------------- -------------------- --------------------
SECURITIES SOLD, NOT YET PURCHASED (CONTINUED):
Common stock (continued):
Canada:
Products and services .02% $ 9,209
Transportation .18 94,800
------------------ -------------------------------------------------------- -------------------- --------------------
TOTAL COMMON STOCK - CANADA
(PROCEEDS $75,763) .20 104,009
------------------ -------------------------------------------------------- -------------------- --------------------
France:
Telecommunications .03 15,226
------------------ -------------------------------------------------------- -------------------- --------------------
TOTAL COMMON STOCK - FRANCE
(PROCEEDS $16,921) .03 15,226
------------------ -------------------------------------------------------- -------------------- --------------------
Germany:
Chemicals .07 35,531
------------------ -------------------------------------------------------- -------------------- --------------------
TOTAL COMMON STOCK - GERMANY
(PROCEEDS $29,978) .07 35,531
------------------ -------------------------------------------------------- -------------------- --------------------
Mexico:
Media, entertainment and leisure .34 178,275
------------------ -------------------------------------------------------- -------------------- --------------------
TOTAL COMMON STOCK - MEXICO
(PROCEEDS $178,332) .34 178,275
------------------ -------------------------------------------------------- -------------------- --------------------
United Kingdom:
Business services .34 179,369
------------------ -------------------------------------------------------- -------------------- --------------------
TOTAL COMMON STOCK - UNITED KINGDOM
(PROCEEDS $177,892) .34 179,369
------------------ -------------------------------------------------------- -------------------- --------------------
TOTAL COMMON STOCK (PROCEEDS $13,483,917) 26.23 13,710,190
------------------ -------------------------------------------------------- -------------------- --------------------
=========================================================================== ==================== ====================
See accompanying summary of business and significant accounting policies
and notes to financial statements.
21
EAGLEROCK MASTER FUND, LP
CONDENSED SCHEDULE OF INVESTMENTS
(EXPRESSED IN US DOLLARS)
=========================================================================== ==================== ====================
December 31, 2007
--------------------------------------------------------------------------- -------------------- --------------------
Number of Description % of net assets Market or
shares/face value of $52,282,078 fair value
------------------ -------------------------------------------------------- -------------------- --------------------
SECURITIES SOLD, NOT YET PURCHASED (CONTINUED):
Long-term debt securities:
United States:
Automotive 5.27% $ 2,755,250
Financial services .81 423,000
Food processing .21 107,500
Media, entertainment and leisure 7.84 4,099,900
Packaging and containers 2.32 1,214,625
Residential construction 1.64 856,750
Retail:
3,000,000 RadioShack Corp., 7.375%, 5/15/11 5.68 2,970,000
------------------ -------------------------------------------------------- -------------------- --------------------
TOTAL LONG-TERM DEBT SECURITIES
(PROCEEDS $13,377,718) 23.77 12,427,025
------------------ -------------------------------------------------------- -------------------- --------------------
Options written:
United States 22.13 11,567,475
------------------ -------------------------------------------------------- -------------------- --------------------
TOTAL OPTIONS WRITTEN
(PROCEEDS $10,399,529) 22.13 11,567,475
------------------ -------------------------------------------------------- -------------------- --------------------
TOTAL SECURITIES SOLD, NOT YET PURCHASED
(PROCEEDS $37,261,164) 72.13% $37,704,690
------------------ -------------------------------------------------------- -------------------- --------------------
=========================================================================== ==================== ====================
See accompanying summary of business and significant accounting policies
and notes to financial statements.
22
EAGLEROCK MASTER FUND, LP
CONDENSED SCHEDULE OF INVESTMENTS
(EXPRESSED IN US DOLLARS)
=========================================================================== ==================== ====================
December 31, 2006
--------------------------------------------------------------------------- -------------------- --------------------
Number of Description % of net assets of Market or
shares/face value $89,977,744 fair value
------------------ -------------------------------------------------------- -------------------- --------------------
INVESTMENTS IN SECURITIES:
Common stock:
United States:
Automotive:
7,118,709 Delphi Corporation 30.22% $ 27,193,468
Other 2.05 1,846,043
Building materials:
1,059,811 Owens Corning 5.89 5,297,179
Other .88 791,000
Business services 7.15 6,436,431
Capital equipment 1.07 959,805
Chemicals:
8,556,643 Solutia, Inc. 7.08 6,374,699
Other 3.50 3,149,953
Consumer products:
2,039,742 Interstate Bakeries Corp. 5.44 4,895,381
Other 3.66 3,291,724
Electronics 3.27 2,939,609
Energy 5.62 5,056,693
Financial services 2.13 1,919,922
Food processing:
2,633,716 Darling International, Inc. 16.13 14,511,775
Other .09 83,554
Health care .63 567,133
Index:
139,421 S&P depository receipts 21.94 19,744,802
Media, entertainment and leisure 10.01 9,007,747
Mining and metals:
199,348 WCI Steel, Inc. 3.54 3,189,568
Other 8.72 7,838,397
Networking 4.04 3,631,341
Packaging and containers:
1,680,115 Constar International, Inc. 13.07 11,760,805
15,000 Graphic Packaging Corp. .07 64,950
Other 1.23 1,109,157
Paper and paper products .32 288,547
------------------ -------------------------------------------------------- -------------------- --------------------
=========================================================================== ==================== ====================
See accompanying summary of business and significant accounting policies
and notes to financial statements.
23
EAGLEROCK MASTER FUND, LP
CONDENSED SCHEDULE OF INVESTMENTS
(EXPRESSED IN US DOLLARS)
=========================================================================== ==================== ====================
December 31, 2006
--------------------------------------------------------------------------- -------------------- --------------------
Number of Description % of net assets of Market or
shares/face value $89,977,744 fair value
------------------ -------------------------------------------------------- -------------------- --------------------
INVESTMENTS IN SECURITIES (CONTINUED):
Common stock (continued):
United States (continued):
Pharmaceuticals and biotechnology 1.51% $ 1,361,866
Retail 4.54 4,087,682
Semiconductors 1.21 1,092,514
Software 2.24 2,014,617
Telecommunications 5.70 5,129,087
Transportation:
395,581 Delta Air Lines, Inc. .57 514,255
Other 3.23 2,902,894
Utilities 2.33 2,092,785
Wireless communications 2.88 2,591,667
------------------ -------------------------------------------------------- -------------------- --------------------
TOTAL COMMON STOCK - UNITED STATES
(COST $115,139,614) 181.96 163,737,050
------------------ -------------------------------------------------------- -------------------- --------------------
Bermuda:
Pharmaceutical and biotech .23 208,404
Telecommunications 1.04 934,594
------------------ -------------------------------------------------------- -------------------- --------------------
TOTAL COMMON STOCK - BERMUDA
(COST $1,193,841) 1.27 1,142,998
------------------ -------------------------------------------------------- -------------------- --------------------
Canada:
Mining and metals .74 661,602
Transportation and defense .87 779,108
------------------ -------------------------------------------------------- -------------------- --------------------
TOTAL COMMON STOCK - CANADA
(COST $1,344,271) 1.61 1,440,710
------------------ -------------------------------------------------------- -------------------- --------------------
China:
Automotive .21 192,014
------------------ -------------------------------------------------------- -------------------- --------------------
TOTAL COMMON STOCK - CHINA
(COST $154,164) .21 192,014
------------------ -------------------------------------------------------- -------------------- --------------------
England:
Media, entertainment and leisure .47 420,719
Mining and metals .47 419,715
Telecommunications .02 19,391
------------------ -------------------------------------------------------- -------------------- --------------------
TOTAL COMMON STOCK - ENGLAND
(COST $781,739) .96 859,825
------------------ -------------------------------------------------------- -------------------- --------------------
=========================================================================== ==================== ====================
See accompanying summary of business and significant accounting policies
and notes to financial statements.
24
EAGLEROCK MASTER FUND, LP
CONDENSED SCHEDULE OF INVESTMENTS
(EXPRESSED IN US DOLLARS)
=========================================================================== ==================== ====================
December 31, 2006
--------------------------------------------------------------------------- -------------------- --------------------
Number of Description % of net assets of Market or
shares/face value $89,977,744 fair value
------------------ -------------------------------------------------------- -------------------- --------------------
INVESTMENTS IN SECURITIES (CONTINUED):
Common stock (continued):
France:
Telecommunications .46% $ 417,713
------------------ -------------------------------------------------------- -------------------- --------------------
TOTAL COMMON STOCK - FRANCE
(COST $393,037) .46 417,713
------------------ -------------------------------------------------------- -------------------- --------------------
Germany:
Financial services .04 39,550
------------------ -------------------------------------------------------- -------------------- --------------------
TOTAL COMMON STOCK - GERMANY
(COST $329,567) .04 39,550
------------------ -------------------------------------------------------- -------------------- --------------------
India:
Media, entertainment and leisure .33 293,646
------------------ -------------------------------------------------------- -------------------- --------------------
TOTAL COMMON STOCK - INDIA
(COST $290,495) .33 293,646
------------------ -------------------------------------------------------- -------------------- --------------------
Italy:
Food processing .07 63,320
------------------ -------------------------------------------------------- -------------------- --------------------
TOTAL COMMON STOCK - ITALY
(COST $57,295) .07 63,320
------------------ -------------------------------------------------------- -------------------- --------------------
Taiwan:
Semiconductors .10 91,312
------------------ -------------------------------------------------------- -------------------- --------------------
TOTAL COMMON STOCK - TAIWAN
(COST $88,389) .10 91,312
------------------ -------------------------------------------------------- -------------------- --------------------
TOTAL COMMON STOCK
(COST $119,772,412) 187.01 168,278,138
------------------ -------------------------------------------------------- -------------------- --------------------
Long-term debt securities:
United States:
Automotive 4.78 4,302,632
Business services 1.65 1,487,700
Financial services .46 409,500
Media, entertainment and leisure 6.08 5,472,854
Mining and metals:
2,750,000 WCI Steel, Inc. 8.00% 5/1/16 3.03 2,722,500
15,750,000 WCI Steel, Inc. 10.00% 12/1/04
Sr Nts. (in default) .34 307,125
Other .77 699,750
Packaging and containers .18 165,454
------------------ -------------------------------------------------------- -------------------- --------------------
=========================================================================== ==================== ====================
See accompanying summary of business and significant accounting policies
and notes to financial statements.
25
EAGLEROCK MASTER FUND, LP
CONDENSED SCHEDULE OF INVESTMENTS
(EXPRESSED IN US DOLLARS)
=========================================================================== ==================== ====================
December 31, 2006
--------------------------------------------------------------------------- -------------------- --------------------
Number of Description % of net assets of Market or
shares/face value $89,977,744 fair value
------------------ -------------------------------------------------------- -------------------- --------------------
INVESTMENTS IN SECURITIES (CONTINUED):
Long-term debt securities (continued):
United States (continued):
Semiconductors .30% $ 271,500
Telecommunications 4.43 3,990,193
Transportation:
11,040,000 Delta Air Lines Inc. 8.3% 12/15/29 8.22 7,396,800
900,000 Delta Air Lines Inc. 2.88% 02/18/24 .65 582,750
900,000 Delta Air Lines Inc. 7.90% 12/15/09 .66 589,500
Other 4.43 3,988,000
Wireless communications .60 537,188
Utilities .66 594,000
------------------ -------------------------------------------------------- -------------------- --------------------
TOTAL LONG-TERM DEBT SECURITIES - UNITED 37.24 33,517,446
STATES (COST $27,113,890)
------------------ -------------------------------------------------------- -------------------- --------------------
Bermuda:
Pharmaceuticals and biotechnology 2.06 1,849,500
Telecommunications .52 469,500
------------------ -------------------------------------------------------- -------------------- --------------------
TOTAL LONG-TERM DEBT SECURITIES - 2.58 2,319,000
BERMUDA (COST $1,350,006)
------------------ -------------------------------------------------------- -------------------- --------------------
Canada:
Electronics 3.31 2,975,469
------------------ -------------------------------------------------------- -------------------- --------------------
TOTAL LONG-TERM DEBT SECURITIES - CANADA 3.31 2,975,469
(COST $3,056,205)
------------------ -------------------------------------------------------- -------------------- --------------------
Mexico:
Telecommunications 2.78 2,497,389
------------------ -------------------------------------------------------- -------------------- --------------------
TOTAL LONG-TERM DEBT SECURITIES - MEXICO 2.78 2,497,389
(COST $1,654,435)
------------------ -------------------------------------------------------- -------------------- --------------------
United Kingdom:
Automotive 3.45 3,102,500
Telecommunications 2.63 2,368,458
------------------ -------------------------------------------------------- -------------------- --------------------
TOTAL LONG-TERM DEBT SECURITIES - UNITED 6.08 5,470,958
KINGDOM (COST $2,844,527)
------------------ -------------------------------------------------------- -------------------- --------------------
TOTAL LONG-TERM DEBT SECURITIES 51.99 46,780,262
(COST $36,019,063)
------------------ -------------------------------------------------------- -------------------- --------------------
=========================================================================== ==================== ====================
See accompanying summary of business and significant accounting policies
and notes to financial statements.
26
EAGLEROCK MASTER FUND, LP
CONDENSED SCHEDULE OF INVESTMENTS
(EXPRESSED IN US DOLLARS)
=========================================================================== ==================== ====================
December 31, 2006
--------------------------------------------------------------------------- -------------------- --------------------
Number of Description % of net assets of Market or
shares/face value $89,977,744 fair value
------------------ -------------------------------------------------------- -------------------- --------------------
INVESTMENTS IN SECURITIES (CONTINUED):
Preferred stock:
United States:
Media, entertainment and leisure .28% $ 252,450
Mining and metals:
317,716 WCI Steel, Inc. 6.78 6,100,147
Pharmaceuticals and biotechnology 1.00 900,900
------------------ -------------------------------------------------------- -------------------- --------------------
TOTAL PREFERRED STOCK (COST $5,225,629) 8.06 7,253,497
------------------ -------------------------------------------------------- -------------------- --------------------
Options purchased:
Canada .04 38,813
United States 2.52 2,265,102
------------------ -------------------------------------------------------- -------------------- --------------------
TOTAL OPTIONS PURCHASED (COST $2,813,760) 2.56 2,303,915
------------------ -------------------------------------------------------- -------------------- --------------------
TOTAL INVESTMENTS IN SECURITIES
(COST $163,830,864) 249.62% $224,615,812
------------------ -------------------------------------------------------- -------------------- --------------------
=========================================================================== ==================== ====================
See accompanying summary of business and significant accounting policies
and notes to financial statements.
27
EAGLEROCK MASTER FUND, LP
CONDENSED SCHEDULE OF INVESTMENTS
(EXPRESSED IN US DOLLARS)
=========================================================================== ==================== ====================
December 31, 2006
--------------------------------------------------------------------------- -------------------- --------------------
Number of Description % of net assets of Market or
shares/face value $89,977,744 fair value
------------------ -------------------------------------------------------- -------------------- --------------------
SECURITIES SOLD, NOT YET PURCHASED:
Common stock:
United States:
Automotive:
3,040,007 Delphi Corporation 12.91% $ 11,612,827
Other .08 68,224
Building materials:
497,131 Owens Corning 3.94 3,546,020
Capital equipment .05 44,630
Consumer products 1.12 1,006,425
Electronics .08 69,333
Energy .40 364,060
Food processing:
75,000 Darling International, Inc. .46 413,250
Other .55 495,041
Financial services .07 64,570
Index:
189,670 S&P depository receipts 29.85 26,861,065
Media, entertainment and leisure .07 65,507
Networking .07 65,835
Paper and paper products .01 10,117
Retail 1.69 1,521,985
Semiconductors .28 252,490
Transportation:
153,061 Delta Air Lines, Inc. .22 198,979
Other .38 342,375
Utilities 1.72 1,545,668
------------------ -------------------------------------------------------- -------------------- --------------------
TOTAL COMMON STOCK - UNITED STATES 53.95 48,548,401
(PROCEEDS $46,584,384)
------------------ -------------------------------------------------------- -------------------- --------------------
Canada:
Financial services - 1,504
Mining and metals .31 274,576
Networking .07 63,404
Transportation .33 296,076
------------------ -------------------------------------------------------- -------------------- --------------------
TOTAL COMMON STOCK - CANADA .71 635,560
(PROCEEDS $617,004)
------------------ -------------------------------------------------------- -------------------- --------------------
=========================================================================== ==================== ====================
See accompanying summary of business and significant accounting policies
and notes to financial statements.
28
EAGLEROCK MASTER FUND, LP
CONDENSED SCHEDULE OF INVESTMENTS
(EXPRESSED IN US DOLLARS)
=========================================================================== ==================== ====================
December 31, 2006
--------------------------------------------------------------------------- -------------------- --------------------
Number of Description % of net assets of Market or
shares/face value $89,977,744 fair value
------------------ -------------------------------------------------------- -------------------- --------------------
SECURITIES SOLD, NOT YET PURCHASED (CONTINUED):
Common stock (continued):
United Kingdom:
Business services .04% $ 34,567
------------------ -------------------------------------------------------- -------------------- --------------------
TOTAL COMMON STOCK - UNITED KINGDOM .04 34,567
(PROCEEDS $30,424)
------------------ -------------------------------------------------------- -------------------- --------------------
TOTAL COMMON STOCK PROCEEDS $47,231,812) 54.70 49,218,528
------------------ -------------------------------------------------------- -------------------- --------------------
Long-term debt securities:
United States:
Automotive 3.86 3,474,001
Chemicals 3.30 2,970,000
Media, entertainment and leisure 7.30 6,572,375
Mining and metals:
1,500,000 WCI Steel, Inc. 8.00% 5/1/16 1.65 1,485,000
Other 1.79 1,612,875
Packaging and containers:
5,850,000 Graphic Packaging Corp. 9.5% 8/15/13 6.89 6,201,000
Other 4.49 4,036,802
Retail:
5,000,000 Radio Shack 7.375% 5/15/11 5.69 5,115,900
Transportation and defense 2.56 2,300,000
Utilities:
8,000,000 AES Corp. 8.75% 6/15/08 9.22 8,300,000
------------------ -------------------------------------------------------- -------------------- --------------------
TOTAL LONG-TERM DEBT SECURITIES - UNITED 46.75 42,067,953
STATES (PROCEEDS $42,471,754)
------------------ -------------------------------------------------------- -------------------- --------------------
Bermuda:
Pharmaceuticals and biotechnology:
6,300,000 U.S. Steel 9.75% 5/15/10 7.49 6,741,000
------------------ -------------------------------------------------------- -------------------- --------------------
TOTAL LONG-TERM DEBT SECURITIES - 7.49 6,741,000
BERMUDA (PROCEEDS $6,945,744)
------------------ -------------------------------------------------------- -------------------- --------------------
TOTAL LONG-TERM DEBT SECURITIES 54.24 48,808,953
(PROCEEDS $49,417,498)
------------------ -------------------------------------------------------- -------------------- --------------------
=========================================================================== ==================== ====================
See accompanying summary of business and significant accounting policies
and notes to financial statements.
29
EAGLEROCK MASTER FUND, LP
CONDENSED SCHEDULE OF INVESTMENTS
(EXPRESSED IN US DOLLARS)
=========================================================================== ==================== ====================
December 31, 2006
--------------------------------------------------------------------------- -------------------- --------------------
Number of Description % of net assets of Market or
shares/face value $89,977,744 fair value
------------------ -------------------------------------------------------- -------------------- --------------------
SECURITIES SOLD, NOT YET PURCHASED (CONTINUED):
Options written:
United States 1.09% $ 976,460
------------------ -------------------------------------------------------- -------------------- --------------------
TOTAL OPTIONS WRITTEN (PROCEEDS $1,099,310) 1.09 976,460
------------------ -------------------------------------------------------- -------------------- --------------------
TOTAL SECURITIES SOLD, NOT YET PURCHASED 110.03% $ 99,003,941
(PROCEEDS $97,748,620)
------------------ -------------------------------------------------------- -------------------- --------------------
UNREALIZED LOSS ON OPEN SWAP CONTRACTS:
Credit default swaps 1.46% $ 1,309,844
------------------ -------------------------------------------------------- -------------------- --------------------
TOTAL UNREALIZED LOSS ON OPEN SWAP CONTRACTS 1.46% $ 1,309,844
------------------ -------------------------------------------------------- -------------------- --------------------
=========================================================================== ==================== ====================
See accompanying summary of business and significant accounting policies
and notes to financial statements.
30
EAGLEROCK MASTER FUND, LP
STATEMENTS OF OPERATIONS
(EXPRESSED IN US DOLLARS)
=========================================================================== ==================== ====================
Year ended December 31, 2007 2006 2005
------------------------------------------------------ -------------------- -------------------- --------------------
INVESTMENT INCOME:
Interest $ 2,925,642 $ 3,690,270 $ 10,899,042
Dividends, net of withholding taxes 980,654 2,164,884 1,282,542
Other, net (Note 8) 1,840,888 - -
------------------------------------------------------ -------------------- -------------------- --------------------
TOTAL INVESTMENT INCOME 5,747,184 5,855,154 12,181,584
------------------------------------------------------ -------------------- -------------------- --------------------
EXPENSES:
Interest on securities sold, not yet purchased 3,077,763 4,738,585 11,536,812
Margin interest 1,449,001 1,871,243 1,975,739
Dividends on securities sold, not yet purchased 381,273 1,435,181 425,658
Other, net, primarily stock borrow fees (Note 4) 600,498 1,323,958 2,586,283
------------------------------------------------------ -------------------- -------------------- --------------------
TOTAL EXPENSES 5,508,535 9,368,967 16,524,492
------------------------------------------------------ -------------------- -------------------- --------------------
NET INVESTMENT INCOME (LOSS ) 238,649 (3,513,813) (4,342,908)
NET REALIZED GAIN ON INVESTMENTS 20,643,953 10,685,078 10,430,167
NET CHANGE IN UNREALIZED GAIN ON INVESTMENTS (43,627,081) 28,936,843 (62,562,860)
------------------------------------------------------ -------------------- -------------------- --------------------
NET (LOSS) INCOME (NOTE 2) $(22,744,479) $36,108,108 $(56,475,601)
=========================================================================== ==================== ====================
See accompanying summary of business and significant accounting policies
and notes to financial statements.
31
EAGLEROCK MASTER FUND, LP
STATEMENTS OF CHANGES IN PARTNERS' CAPITAL
(EXPRESSED IN US DOLLARS)
==================================================================================================================================
Three years ended December 31, 2007
----------------------------------------------------------------------------------------------------------------------------------
EagleRock Capital EagleRock Capital EagleRock Capital Total
Partners Offshore
Partners QP, L.P. Partners, L.P. Fund, Ltd.
-------------------------------------- ---------------------- ---------------------- ---------------------- ----------------------
BALANCE, JANUARY 1, 2005 $163,520,126 $ 32,914,821 $ 29,906,469 $ 226,341,416
Capital contributions - 5,500,000 35,700,000 41,200,000
Capital withdrawals (3,484,918) (9,037,074) (8,879,999) (21,401,991)
Net loss (Note 2):
Pro rata allocation (37,096,440) (6,907,641) (12,471,520) (56,475,601)
-------------------------------------- ---------------------- ---------------------- ---------------------- ----------------------
-------------------------------------- ---------------------- ---------------------- ---------------------- ----------------------
BALANCE, DECEMBER 31, 2005 122,938,768 22,470,106 44,254,950 189,663,824
Capital withdrawals (73,483,842) (10,188,618) (52,121,728) (135,794,188)
Net income (Note 2):
Pro rata allocation 23,122,284 5,119,046 7,866,778 36,108,108
-------------------------------------- ---------------------- ---------------------- ---------------------- ----------------------
-------------------------------------- ---------------------- ---------------------- ---------------------- ----------------------
BALANCE, DECEMBER 31, 2006 72,577,210 17,400,534 - 89,977,744
Capital contributions 555 1,090 10,059,194 10,060,839
Capital withdrawals (22,456,079) (2,514,877) (41,070) (25,012,026)
Net loss (Note 2):
Pro rata allocation (14,589,214) (4,555,289) (3,599,976) (22,744,479)
-------------------------------------- ---------------------- ---------------------- ---------------------- ----------------------
BALANCE, DECEMBER 31, 2007 $ 35,532,472 $ 10,331,458 $ 6,418,148 $ 52,282,078
==================================================================================================================================
See accompanying summary of business and significant accounting policies
and notes to financial statements.
32
EAGLEROCK MASTER FUND, LP
STATEMENTS OF CHANGES IN NET ASSETS
(EXPRESSED IN US DOLLARS)
=====================================================================================================================
Year ended December 31, 2007 2006 2005
------------------------------------------------------ -------------------- -------------------- --------------------
(DECREASE) INCREASE IN NET ASSETS FROM OPERATIONS:
Net investment income (loss ) $ 238,649 $ (3,513,813) $ (4,342,908)
Net realized gain on investments 20,643,953 10,685,078 10,430,167
Net change in unrealized gain on investments (43,627,081) 28,936,843 (62,562,860)
------------------------------------------------------ -------------------- -------------------- --------------------
NET (DECREASE) INCREASE IN NET ASSETS
RESULTING FROM OPERATIONS (22,744,479) 36,108,108 (56,475,601)
------------------------------------------------------ -------------------- -------------------- --------------------
(DECREASE) INCREASE IN NET ASSETS FROM CAPITAL
TRANSACTIONS:
Capital contributions 10,060,839 - 41,200,000
Capital withdrawals (16,237,934) (96,902,106) (21,401,991)
Capital withdrawals payable (8,774,092) (38,892,082) -
------------------------------------------------------ -------------------- -------------------- --------------------
NET (DECREASE) INCREASE IN NET ASSETS
RESULTING FROM CAPITAL TRANSACTIONS (14,951,187) (135,794,188) 19,798,009
------------------------------------------------------ -------------------- -------------------- --------------------
TOTAL DECREASE (37,695,666) (99,686,080) (36,677,592)
NET ASSETS, BEGINNING OF YEAR 89,977,744 189,663,824 226,341,416
------------------------------------------------------ -------------------- -------------------- --------------------
NET ASSETS, END OF YEAR $ 52,282,078 $ 89,977,744 $189,663,824
=====================================================================================================================
See accompanying summary of business and significant accounting policies
and notes to financial statements.
33
EAGLEROCK MASTER FUND, LP
SUMMARY OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
(EXPRESSED IN US DOLLARS)
================================================================================
BUSINESS EagleRock Master Fund, LP ("Partnership")
is a Cayman Islands exempted partnership
that invests and trades in securities and
other investment vehicles and instruments.
EagleRock Capital Partners, LP, EagleRock
Capital Partners (QP), LP and EagleRock
Capital Partners Offshore Fund, Ltd.
(collectively "Feeder Funds") are all
entities under common control and are the
general and limited partners of the
Partnership. Mariel Capital Management,
LLC is also a general partner of the
Partnership and had no capital balance at
December 31, 2007, 2006 and 2005.
SIGNIFICANT ACCOUNTING POLICIES Basis of Presentation
The financial statements are presented in
United States ("U.S.") dollars in
accordance with accounting principles
generally accepted in the United States of
America.
Investment Transactions
The Partnership records all security
transactions and related expenses on a
trade date basis. Revenues and expenses
are recorded on the accrual basis.
Dividends are recorded on the ex-dividend
date and interest is accrued in the period
earned.
34
EAGLEROCK MASTER FUND, LP
SUMMARY OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
(EXPRESSED IN US DOLLARS)
================================================================================
Investment Valuation
Securities and other investments listed or
traded on a national securities exchange
or on the national market system of NASDAQ
are valued at their last sales price on
the date of valuation or if there has been
no sale on that date, at the mean of the
bid (for investments) or ask (for
securities sold, not yet purchased) prices
supplied by market making broker-dealers
at the close of business. Certain
long-term debt and other securities for
which quotations are not readily available
are valued at estimated fair value as
determined in good faith by the General
Partners. The values assigned to such
investments are based upon available
information and do not necessarily
represent amounts which might ultimately
be realized. Because of the inherent
uncertainty of valuation, those estimated
fair values may differ from the values
that would have been used had a ready
market for the investments existed and
those differences could be material. The
resulting unrealized gains and losses are
reflected in the statements of operations.
Accounting for Derivative Instruments and
Hedging Activities
The Partnership recognizes all derivatives
as either assets or liabilities in the
statement of assets and liabilities and
measures those instruments at fair value.
Fair values for derivatives traded on a
national exchange, principally certain
options, are based on quoted market
prices.
35
EAGLEROCK MASTER FUND, LP
SUMMARY OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
(EXPRESSED IN US DOLLARS)
================================================================================
The Partnership uses purchased and written
option contracts as part of its investment
strategy and to manage market risk. Option
contracts are contractual agreements that
give the purchaser the right, but not the
obligation, to purchase or sell a
financial instrument at a predetermined
exercise price. In return for this right,
the purchaser pays a premium to the seller
of the option. By selling or writing
options, the Partnership receives a
premium and becomes obligated during the
term of the option to purchase or sell a
financial instrument at a predetermined
exercise price if the option is exercised,
and assumes the risk of not being able to
enter into a closing transaction if a
liquid secondary market does not exist.
Option contracts are recorded in the
statement of assets and liabilities at
fair value as discussed above. Gains and
losses on option contracts are recorded in
the statements of operations in net
realized and unrealized gain/loss on
investments.
The Partnership enters into credit default
swaps which are agreements in which one
party pays fixed periodic payments to a
counterparty in consideration for a
guarantee from the counterparty to make a
specific payment should a negative credit
event take place. Risks arise from the
possible inability of counterparties to
meet the terms of their contracts. The
unrealized gains or losses on open credit
default swaps are included on the
statements of assets and liabilities, with
net changes in unrealized gains or losses
included in the statements of operations.
Foreign Currency
Investment securities and other assets and
liabilities denominated in foreign
currencies are translated into U.S. dollar
amounts at the date of valuation.
Purchases and sales of investment
securities and income and expense items
denominated in foreign currencies are
translated into U.S. dollar amounts on the
respective dates of such transactions.
36
EAGLEROCK MASTER FUND, LP
SUMMARY OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
(EXPRESSED IN US DOLLARS)
================================================================================
The Partnership does not isolate that
portion of the results of operations
resulting from changes in foreign exchange
rates on investments from the fluctuations
arising from changes in market prices of
securities held. Such fluctuations are
included with the net realized and
unrealized gain or loss from investments.
Income Taxes
The Partnership is exempt from all forms
of taxation in the Cayman Islands
including income, capital gains and
withholding taxes. In jurisdictions other
than the Cayman Islands, foreign taxes may
be withheld on dividends and interest
received by the Partnership at rates up to
30%. Capital gains derived by the
Partnership are generally exempt from
foreign income or withholding taxes at
source. Dividend income is recorded net of
any such withholding taxes.
In July 2006, the Financial Accounting
Standards Board (the "FASB") issued FASB
Interpretation No. 48 ("FIN 48"),
"Accounting for Uncertainty in Income
Taxes", which establishes that a tax
position taken or expected to be taken in
a tax return is to be recognized in the
financial statements when it is more
likely than not, based on the technical
merits, that the position will be
sustained upon examination. FIN 48 is
effective for fiscal years beginning after
December 15, 2007. The adoption of FIN 48
did not have a material impact on the
Partnership's results of operations or its
financial position.
Use of Estimates
The preparation of financial statements in
conformity with accounting principles
generally accepted in the United States of
America requires management to make
estimates and assumptions that affect the
reported amounts of assets and liabilities
and disclosure of contingent assets and
liabilities at the date of the financial
statements and the reported amounts of
revenues and expenses during the reporting
year. Actual results could differ from
those estimates.
37
EAGLEROCK MASTER FUND, LP
SUMMARY OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
(EXPRESSED IN US DOLLARS)
================================================================================
New Accounting Pronouncement
In September 2006, the FASB issued
Statement of Financial Accounting
Standards ("SFAS") No. 157, "Fair Value
Measurements". This standard clarifies the
definition of fair value for financial
reporting, establishes a framework for
measuring fair value and requires
additional disclosures about the use of
fair value measurements. SFAS No. 157 is
effective for financial statements issued
for fiscal years beginning after November
15, 2007 and interim periods within those
fiscal years. As of December 31, 2007, the
Partnership does not believe the adoption
of SFAS No. 157 will impact the amounts
reported in the financial statements.
However, additional disclosures will be
required about the inputs used to develop
the measurements of fair value and the
effect of certain of the measurements
reported in the statement of operations
for a fiscal year.
38
EAGLEROCK MASTER FUND, LP
NOTES TO FINANCIAL STATEMENTS
(EXPRESSED IN US DOLLARS)
================================================================================
1. DUE FROM BROKERS, NET The Partnership has agreements with
brokerage firms to carry its customer
account. These brokers have custody of
the Partnership's securities and, from
time to time, cash balances, which may be
due from these brokers.
These securities and/or cash positions
serve as collateral for any amounts due to
brokers as well as collateral for
securities sold, not yet purchased.
The Partnership is subject to credit risk
if the brokers are unable to repay
balances due or deliver securities in
their custody.
2. ALLOCATION OF NET The net income (loss) for each of the
INCOME (LOSS) three years ended December 31, 2007 is
allocated to each partner in accordance
with the ratio of the capital account of
each partner to the total of all capital
accounts at the beginning of each fiscal
period.
3. FEEDER FUND MANAGEMENT EagleRock Capital Management, LLC
FEES ("Investment Manager") serves as the
Investment Manager of the Partnership.
The Partnership pays a quarterly
management fee on behalf of its three
Feeder Funds. During the three years
ended December 31, 2006, the Partnership
paid the 2007, 2006 and 2005 management
fee and was reimbursed by the Feeder
Funds in the form of a capital withdrawal
which amounted to $708,248, $1,728,389
and $2,898,515, respectively.
4. INVESTMENTS IN The Partnership has entered into certain
SECURITIES PLEDGED TO stock borrow agreements. At December 31,
COUNTERPARTY 2007 and 2006, the Partnership has
pledged $7,043,107 and $10,498,542,
respectively, of investments in
securities related to stock borrow
transactions. For the years ended
December 31, 2007, 2006 and 2005, stock
borrow fees charged by the broker
amounted to $586,047, $1,314,732 and
$2,588,754, respectively, and are
included in other expenses in the
statements of operations.
39
EAGLEROCK MASTER FUND, LP
NOTES TO FINANCIAL STATEMENTS
(EXPRESSED IN US DOLLARS)
================================================================================
5. FINANCIAL INSTRUMENTS The Partnership invests in marketable
WITH OFF-BALANCE SHEET securities and is exposed to market risks
RISK resulting from changes in the fair value
of their investments. Derivative
financial instruments are used by the
Partnership to help manage such market
risk.
Securities sold, not yet purchased by the
Partnership, may give rise to off-balance
sheet risk. The Partnership may sell a
security it does not own in anticipation
of a decline in the fair value of that
security. When the Partnership sells a
security short, it must borrow the
security sold short. A gain, limited to
the price at which the Partnership sold
the security short, or a loss, unlimited
in amount, will be recognized upon the
termination of a short sale. The
Partnership has recorded this obligation
in the financial statements at the
December 31, 2007 and 2006 market value of
these securities. There is an element of
market risk in that, if the securities
increase in value, it will be necessary to
purchase the securities at a cost in
excess of the price reflected in the
statement of assets and liabilities. The
amounts reflected in investments in
securities and securities sold, not yet
purchased include $4,818,319 and
$41,276,945 of identical securities held
both long and short at December 31, 2007
and 2006, respectively.
The Partnership is exposed to
credit-related losses in the event of
nonperformance by counterparties to
financial instruments, but it does not
expect any counterparties to fail to meet
their obligations.
6. CAPITAL TRANSACTIONS Capital Withdrawals Payable
At December 31, 2007, $8,774,092 was
payable to the Feeder Funds for capital
withdrawals. As of March 7, 2008, the Fund
made payments for such capital withdrawals
totaling $8,616,029.
At December 31, 2006, $38,892,082 was
payable to the Feeder Funds for capital
withdrawals. During 2007, the Partnership
made payments for such capital
withdrawals.
40
EAGLEROCK MASTER FUND, LP
NOTES TO FINANCIAL STATEMENTS
(EXPRESSED IN US DOLLARS)
================================================================================
Subsequent Capital Transactions
From January 1, 2008 to March 7, 2008, the
Fund made payment for capital withdrawals
totaling $8,616,029 (see above). There
were no other capital contributions or
withdrawals in the same period.
7. CONTINGENCIES Regulatory Inquiries
From time to time, the Partnership and its
affiliates receive inquiries from
regulatory agencies. The Partnership and
its affiliates fully cooperate with such
inquiries. It is not possible to predict
the outcome of such inquiries.
Guarantees
The Partnership may be obligated to make a
payment upon a default of significant
change in the credit quality or the
underlying financial instrument of the
credit default swap contract. In
connection with these contracts, the
Partnership attempts to mitigate its
exposure to market risk by entering into
offsetting derivatives contracts and
security positions.
Under this guarantee, the Partnership is
theoretically exposed to a potential
maximum payout (notional amount) of
approximately $2.0 million.
8. OTHER INCOME For the year ended December 31, 2007, the
Partnership had $1,750,000, included in
other income, net with respect to
brokerage concessions from a broker.
9. FINANCIAL HIGHLIGHTS The financial highlights represent the
Partnership's financial performance for
the three years ended December 31, 2007.
An individual partner's performance may
vary based on the timing of capital
transactions.
41
EAGLEROCK MASTER FUND, LP
NOTES TO FINANCIAL STATEMENTS
(EXPRESSED IN US DOLLARS)
================================================================================
Total return is computed based on the
change in a limited partner capital
account during the year, adjusted for
capital contribution and withdrawals.
Limited partner 2007 2006 2005
-------------------------------------- ------------- ------------- -------------
Total return (27.60)% 27.28% (23.13)%
-------------------------------------- ------------- ------------- -------------
PERCENTAGES TO AVERAGE NET ASSETS:
Operating expense ratio 6.60% 6.60% 7.45%
-------------------------------------- ------------- ------------- -------------
Net investment income (loss) ratio .30% 2.48% (1.96)%
-------------------------------------- ------------- ------------- -------------
42
JEFFERIES PARTNERS OPPORTUNITY FUND II, LLC
Financial Statements
As of and for the three-month period ended March 31, 2007
(Unaudited)
JEFFERIES PARTNERS OPPORTUNITY FUND II, LLC
Statement of Financial Condition (Unaudited)
March 31, 2007
Assets
Cash and cash equivalents $ 15,491,008
Receivable from affiliated brokers and dealers 34,867,632
Securities owned 125,109,809
Securities borrowed 14,018,530
Other assets 411,797
----------------
Total assets $ 189,898,776
================
Liabilities and Members' Equity
Bank loans $ 7,047,145
Securities sold, not yet purchased 29,180,220
Payable to affiliated brokers and dealers 21,059,232
Payable to Jefferies & Company, Inc. 349,487
Accrued expenses and other liabilities 273,495
----------------
Total liabilities 57,909,579
----------------
Members' equity: 131,989,197
----------------
Total liabilities and members' equity $ 189,898,776
================
See accompanying notes to financial statements.
1
JEFFERIES PARTNERS OPPORTUNITY FUND II, LLC
Statement of Earnings (Unaudited)
Three-month period ended March 31, 2007
Revenues:
Principal transactions, net of direct trading
expenses (See Note 5) $3,857,253
Interest:
Interest income 1,043,799
Interest expense (197,145)
----------
Net interest 846,654
----------
Net revenues 4,703,907
----------
Expenses:
General and administrative 212,346
Management fee 362,632
----------
Total expenses 574,978
----------
Net income $4,128,929
==========
See accompanying notes to financial statements.
2
JEFFERIES PARTNERS OPPORTUNITY FUND II, LLC
Statement of Changes in Members' Equity (Unaudited)
Three-month period ended March 31, 2007
Total
Class B members'
Members Member equity
------------- ------------ -------------
Balance, December 31, 2006 $ 167,209,374 $ 1,000 $ 167,210,374
Allocation of carried interest (5,824,273) 5,824,273 --
Distributions (33,525,833) (5,824,273) (39,350,106)
Net earnings 4,128,929 -- 4,128,929
------------- ----------- -------------
Balance, March 31, 2007 $ 131,988,197 $ 1,000 $ 131,989,197
============== =========== =============
See accompanying notes to financial statements.
3
JEFFERIES PARTNERS OPPORTUNITY FUND II, LLC
Statement of Cash Flows (Unaudited)
Three-month period ended March 31, 2007
Cash flows from operating activities:
Net income $ 4,128,929
Adjustments to reconcile net earnings to net cash used in operating activities:
Amortization of financing costs 8,970
Changes in operating assets and liabilities:
Increase in receivable from affiliated brokers and dealers (7,187,572)
Increase in securities owned (5,702,209)
Decrease in securities borrowed 6,263,550
Decrease in other assets 334,875
Decrease in securities sold, not yet purchased (2,777,008)
Increase in payable to affiliated brokers and dealers 3,538,967
Increase in payable to Jefferies & Company, Inc. 96,955
Decrease in accrued expenses and other liabilities (163,693)
-------------
Net cash used in operating activities (1,458,236)
-------------
Cash flows from financing activities:
Proceeds from bank loans 7,047,145
Distributions (39,350,106)
-------------
Net cash used in financing activities (32,302,961)
-------------
Net decrease in cash and cash equivalents (33,761,197)
Cash and cash equivalents at beginning of period 49,252,205
-------------
Cash and cash equivalents at end of period $ 15,491,008
=============
Supplemental disclosures of cash flow information - Cash paid
during the period for interest $ 353,285
See accompanying notes to financial statements.
4
JEFFERIES PARTNERS OPPORTUNITY FUND II, LLC
Notes to Financial Statements (Unaudited)
March 31, 2007
(1) Summary of Significant Accounting Policies
Jefferies Partners Opportunity Fund II, LLC (the "Fund") is a Delaware
limited liability company. The Fund commenced operations on January 19,
2000. The investment objective of the Fund is to generate returns for its
members by making, holding, and disposing of a diverse portfolio of
primarily below investment grade debt and equity investments. The Fund
was established to offer members the opportunity to participate in the
trading, investment, and brokerage activities of the High Yield
Department of Jefferies & Company, Inc. ("Jefferies"). The Fund employs a
trading and investment strategy substantially similar to that
historically employed by Jefferies' High Yield Department. The Fund
acquires, actively manages, and trades a diverse portfolio of primarily
non-investment grade investments consisting of the following three asset
groups: High Yield Debt, Special Situation Investments, and, to a lesser
extent, Bank Loans. The Fund has appointed Jefferies to serve as manager
to the Fund (the "Manager"). The Fund participates in the non-syndicate
trading and investment activities of the High Yield Department on a pari
passu basis with Jefferies. To permit such participation, the Fund has
been registered as a broker dealer under the Securities Exchange Act of
1934 and with the National Association of Securities Dealers.
The Fund was due to terminate on January 18, 2007. The term of the Fund
was extended, as permitted, until January 17, 2008. See subsequent event
disclosure in Footnote 8.
The Fund claims an exemption from Rule 15c3-3 as of March 31, 2007, based
on Section (k)(2)(ii). Securities transactions are cleared through an
affiliated broker dealer on a fully disclosed basis. The Fund does not
execute any securities transactions with or on behalf of any customers.
The Fund prepares its financial statements in conformity with accounting
principles generally accepted in the United States of America ("U.S.
GAAP").
(a) Cash and Cash Equivalents
Cash equivalents consist of money market funds, which are part of
the cash management activities of the Fund, and have original
maturities of 90 days or less. At March 31, 2007, such cash
equivalents amounted to $15,391,387.
(b) Fair Value of Financial Instruments
Substantially all of the Fund's financial instruments are carried
at fair value or amounts approximating fair value. Assets,
including cash and cash equivalents, securities borrowed, and
certain receivables, are carried at fair value or contracted
amounts which approximate fair value due to the short period to
maturity. Similarly, liabilities, including certain payables, are
carried at amounts approximating fair value. Securities and other
inventory positions owned and securities and other inventory
positions sold, but not yet purchased (all of which are recorded
on a trade-date basis) are valued at fair value, with unrealized
gains and losses reflected in Principal transactions in the
Statement of Earnings. The fair value of a financial instrument is
the amount that would be received to sell an asset or paid to
transfer a liability in an orderly transaction between market
participants at the measurement date (the exit price). Securities
and other inventory positions owned and securities and other
inventory positions sold, but not yet purchased are valued at
quoted market prices, if available. For financial instruments that
do not have readily determinable fair values through quoted market
prices, the determination of fair value is based upon
consideration of available information, including types of
financial instruments, current financial information, restrictions
on dispositions, fair values of underlying financial instruments
and quotations for similar instruments.
5
JEFFERIES PARTNERS OPPORTUNITY FUND II, LLC
Notes to Financial Statements (Unaudited)
March 31, 2007
(c) Securities Transactions
The Fund records its securities transactions on a trade-date
basis. Securities owned and securities sold, not yet purchased,
are valued at fair value, and unrealized gains or losses are
reflected in Principal transactions in the Statements of Earnings.
(d) Contributions
Capital contributions were recorded net of the Fund's closing
costs and placement fees. Each member is charged a one-time
placement fee of 1% of gross contributions.
(e) Federal and State Income Taxes
Under current federal and applicable state limited liability
company laws and regulations, limited liability companies are
treated as partnerships for tax reporting purposes and,
accordingly, are not subject to income taxes. Therefore, no
provision for income taxes has been made in the Fund's financial
statements. For tax purposes, income or losses are included in the
tax returns of the members.
(f) Allocation of Income and Expense
Income and expense are allocated 100% to the members based on the
pro rata share of their capital contributed to the Fund until the
total allocation equals the aggregate members' preferred return of
8% of contributed capital. All remaining income and expense are
allocated 80% to the members and 20% to the Class B Member. This
allocation to the Class B Member occurs immediately prior to
distribution of net income.
(g) Use of Estimates
The preparation of financial statements in conformity with U.S.
GAAP requires the Manager to make a number of estimates and
assumptions relating to the reporting of assets and liabilities,
the disclosure of contingent assets and liabilities, and the
reported amounts of revenues and expenses to prepare these
financial statements. Actual results could differ from those
estimates.
(h) New Accounting Pronouncements
FASB No. 157. In September 2006, the Financial Accounting
Standards Board ("FASB") issued FASB No. 157, Fair Value
Measurements ("FASB 157"). FASB 157 clarifies that fair value is
the amount that would be exchanged to sell an asset or transfer a
liability, in an orderly transaction between market participants.
FASB 157 requires that a fair value measurement technique include
an adjustment for risks inherent in a particular valuation
technique (such as a pricing model) and/or the risks inherent in
the inputs to the model, if market participants would also include
such an adjustment. In addition, FASB 157 prohibits the
recognition of "block discounts" for large holdings of
unrestricted financial instruments where quoted prices are readily
and regularly available in an active market. The provisions of
FASB 157 are to be applied prospectively, except for changes in
fair value measurements that result from the initial application
of FASB 157 to block discounts, which are to be recorded as an
adjustment to opening retained earnings in the year of adoption.
FASB 157 is effective for fiscal years beginning after November
15, 2007. The Fund determined that there will be no material
adjustments upon adoption of FASB 157.
6
(Continued)
JEFFERIES PARTNERS OPPORTUNITY FUND II, LLC
Notes to Financial Statements (Unaudited)
March 31, 2007
(2) Receivable from, and Payable to, Affiliated Brokers and Dealers
The following is a summary of the major categories of receivable from,
and payable to, affiliated brokers and dealers as of March 31, 2007:
Receivable from affiliated brokers and dealers:
Securities failed to deliver $ 32,254,138
Other 2,613,494
--------------
$ 34,867,632
==============
Payable to affiliated brokers and dealers:
Securities failed to receive $ 19,814,200
Other 1,245,032
--------------
$ 21,059,232
==============
(3) Securities Owned and Securities Sold, Not Yet Purchased
The following is a summary of the fair value of major categories of
Securities owned and Securities sold, not yet purchased, as of March 31,
2007:
Securities
Securities sold, not yet
owned purchased
-------------- -------------
Corporate debt securities $ 73,142,391 $ 29,180,220
Corporate equity securities 51,967,418 --
-------------- -------------
$ 125,109,809 $ 29,180,220
============== =============
(4) Revolving Credit Facility
In June 2006, the Fund renewed a revolving credit facility agreement with
an unaffiliated third party to be used in connection with the Fund's
investing activities. At March 31, 2007, $85,200,000 was available under
the terms of the revolving credit facility agreement. The revolving
credit facility expires in June 2007, but provides for annual extensions.
Advances under this facility bear interest at the lender's commercial
paper rate plus 115 basis points. The Fund incurs a liquidity fee on the
total amount available under the revolving credit facility. The Fund
incurs a program fee on amounts borrowed under the revolving credit
facility. The Fund incurs a minimum program fee if program fees do not
reach a certain threshold. For the three months ended March 31, 2007, the
Fund was charged a liquidity fee of $79,875, a program fee of $56,688 and
an administrative fee of $98, which are included in Interest expense in
the Statement of Earnings. During the three months ended March 31, 2007,
the Fund borrowed $7,047,145 under the revolving credit facility. For the
three months ended March 31, 2007 the Fund was charged interest of
$25,972 on balances borrowed under the revolving credit facility. At
March 31, 2007, there was $7,047,145 outstanding under the revolving
credit facility.
7
(Continued)
JEFFERIES PARTNERS OPPORTUNITY FUND II, LLC
Notes to Financial Statements (Unaudited)
March 31, 2007
The Fund incurred costs in securing the revolving credit facility. These
costs were capitalized and amortized over seven years. At March 31, 2007,
the costs were fully amortized. For the three months ended March 31,
2007, amortization expense of $8,970 is included in Interest expense in
the Statement of Earnings.
(5) Related Party Transactions
Included in members' equity is an investment in the Fund by Jefferies of
$27,859,268. Additionally, Jefferies, as the Class B Member, contributed
$1,000 of capital for the right to receive a distribution of 20% of the
Fund's distributions in excess of an 8% preferred return paid to the
members. During the three months ended March 31, 2007, the Fund
distributed, in cash, undistributed net income of $39,350,106 to the
members, of which $5,824,273 was distributed to the Class B Member in
accordance with its carried interest.
Receivable from and payable to affiliated brokers and dealers are for
amounts due from and due to Jefferies related to trade execution and
settlement. See Footnote 2.
Included in interest income for the three-month period ended March 31,
2007, is $170,414 of income received from Jefferies Execution Services,
Inc. related to stock borrow transactions. During the three-month period
ended March 31, 2007, Jefferies Execution Services, Inc. was the sole
counterparty to all of the Fund's stock borrow transactions.
As of March 31, 2007, payable to Jefferies & Company, Inc. of $349,487 is
for amounts due for direct trading expenses, general and administrative
expenses, and management fees. Direct trading expenses for the
three-month period ended March 31, 2007, of $572,958 is netted against
principal transactions revenue. The Fund reimburses Jefferies for general
and administrative expenses based on the Fund's pro rata portion of
actual charges incurred. Reimbursed expenses for the three-month period
ended March 31, 2007, of $136,522 are included in General and
administrative expenses.
For the three-month period ended March 31, 2007, the Fund was charged
interest of $25,542 by Jefferies related to securities failed to receive.
Jefferies, in its capacity as Manager, receives a management fee equal to
1% per annum of the sum of 100% of the average balance of securities
owned and 98% of the average balance of securities sold, not yet
purchased. As of March 31, 2007, accrued management fees of $128,353 were
included in Payable to Jefferies & Company, Inc.
8
(Continued)
JEFFERIES PARTNERS OPPORTUNITY FUND II, LLC
Notes to Financial Statements (Unaudited)
March 31, 2007
(6) Financial Instruments
(a) Off-Balance Sheet Risk
The Fund has contractual commitments arising in the ordinary course of
business for securities sold, not yet purchased. These financial
instruments contain varying degrees of off-balance sheet risk whereby the
fair values of the securities underlying the financial instruments may be
in excess of, or less than, the contract amount. The settlement of these
transactions is not expected to have a material effect upon the Fund's
financial statements.
(b) Credit Risk
In the normal course of business, the Fund is involved in the
execution, settlement, and financing of various principal
securities transactions. Securities transactions are subject to
the risk of counterparty nonperformance. However, transactions are
collateralized by the underlying security, thereby reducing the
associated risk to changes in the fair value of the security
through settlement date.
The Fund seeks to control the risk associated with these
transactions by establishing and monitoring collateral and
transaction levels daily.
(c) Concentration of Credit Risk
The Fund's activities are executed exclusively with Jefferies.
Concentrations of credit risk can be affected by changes in
economic, industry, or geographical factors. The Fund seeks to
control its credit risk and the potential risk concentration
through a variety of reporting and control procedures including
those described in the preceding discussion of credit risk.
(7) Net Capital Requirement
The Fund is subject to the Securities and Exchange Commission Uniform Net
Capital Rule (Rule 15c3-1), which requires the maintenance of minimum net
capital. The Fund has elected to use the alternative method permitted by
Rule 15c3-1, which requires that the Fund maintain minimum net capital,
as defined, equal to the greater of $250,000 or 2% of aggregate debit
balances arising from customer transactions, as defined.
At March 31, 2007, the Fund had net capital of $66,344,555, which was
$66,094,555 in excess of required net capital.
(8) Subsequent Events (unaudited)
On April 2, 2007 the Fund was reorganized and became Jefferies High Yield
Trading, LLC ("JHYT"). JHYT is a registered broker-dealer and a
wholly-owned subsidiary of Jefferies High Yield Holdings, LLC. JHYT was
formed to consolidate the secondary market trading activities previously
performed by the High Yield division of Jefferies, the Fund, Jefferies
Partners Opportunity Fund, LLC and Jefferies Employees Opportunity Fund,
LLC (affiliates of the Fund). The activities of JHYT are overseen by the
same management previously responsible for the trading activities of the
Fund. The term of the new arrangement is for six years, with an option to
extend.
Subsequent to March 31, 2007, total cash distributions of undistributed
net income of $4,128,929 were made to the members, of which $314,347 was
distributed to the Class B Member in accordance with its carried
interest.
9
JEFFERIES PARTNERS OPPORTUNITY FUND II, LLC
Financial Statements
December 31, 2006
(Unaudited)
JEFFERIES PARTNERS OPPORTUNITY FUND II, LLC
Statement of Financial Condition
December 31, 2006
(Unaudited)
ASSETS
Cash and cash equivalents $ 49,252,205
Receivable from affiliated brokers and dealers 27,680,060
Securities owned 119,407,600
Securities borrowed 20,282,080
Other assets 755,642
------------
Total assets $217,377,587
============
LIABILITIES AND MEMBERS' EQUITY
Liabilities:
Securities sold, not yet purchased $ 31,957,228
Payable to affiliated brokers and dealers 17,520,265
Payable to Jefferies & Company, Inc. 252,532
Accrued expenses and other liabilities 437,188
------------
Total liabilities 50,167,213
Members' equity 167,210,374
------------
Total liabilities and members' equity $217,377,587
============
See accompanying notes to financial statements.
1
JEFFERIES PARTNERS OPPORTUNITY FUND II, LLC
Condensed Schedule of Investments
December 31, 2006
(Unaudited)
PERCENTAGE
OF MEMBERS'
Description FAIR VALUE EQUITY
------------------------------------------------------- ------------- ------------
Securities owned:
Corporate bonds:
Australia - Mining $ 303,000 0.2%
Bermuda - Telecommunications 102,120 0.1
Canada:
Engineering and Construction 8,000 --
Iron and Steel 1,051,382 0.6
Media 105,886 0.1
Mining 698,660 0.4
Oil and Gas 787,750 0.5
------------ ------
Total Canada 2,651,678 1.6
Cayman Islands - Oil and Gas 3,755 --
Great Britain:
Oil and Gas 4,000 --
Shipping 982,300 0.6
Telecommunications 128,317 0.1
------------ ------
Total Great Britain 1,114,617 0.7
Ireland - Pharmaceuticals 172,840 0.1
Luxembourg - Telecommunications 119,900 0.1
Marshall Island - Transportation 10,000 --
United States:
Aerospace and Defense 4,140 --
Agriculture 1,199,130 0.7
Auto Parts and Equipment 2,044,670 1.2
Beverages 12,477 --
Building Materials 137,475 0.1
Entertainment 51,675 --
Environmental Control 430,027 0.3
Financial Services - Diversified 264,195 0.2
Food 2,329,719 1.4
Healthcare Products and Services 945,091 0.6
Holding Companies-Diversified 13,128 --
Home Builders 491,168 0.3
Household Products 10,525 --
Iron and Steel 2,843,237 1.7
Leisure Time 1,286,780 0.8
Lodging 5,296,650 3.2
Media 3,026,297 1.8
(Continued)
2
JEFFERIES PARTNERS OPPORTUNITY FUND II, LLC
Condensed Schedule of Investments
December 31, 2006
(Unaudited)
PERCENTAGE
OF MEMBERS'
Description FAIR VALUE EQUITY
------------------------------------------------------- ------------- ------------
Metal Fabrication and Hardware 2,245,861 1.3&
Mining $ 363,970 0.2
Miscellaneous Manufacturing 6,579,000 3.9
Office and Business Equipment 10,863 --
Oil and Gas:
Ascent Energy 11.75% 5/1/15 16,100,270 9.6
Ascent Energy 16% 2/1/10 5,543,943 3.3
Oil and Gas - Other 12,742,304 7.6
Packaging and Containers 971,643 0.6
REITS 20,500 --
Retail 916,645 0.5
Semiconductors 110,000 0.1
Storage and Warehousing 8,560 --
Telecommunications 2,263,333 1.4
Transportation 8,524,050 5.1
------------ ------
Total United States 76,787,326 45.9
------------ ------
Total corporate bonds 81,265,236 48.6
Common stock:
Great Britain:
Auto Parts and Equipment 45,862 --
Telecommunications 1,151,150 0.7
------------ ------
Total Great Britain 1,197,012 0.7
United States:
Auto Parts and Equipment 142,120 0.1
Beverages 1,369,323 0.8
Building Materials 4,057,680 2.4
Chemicals 910,800 0.5
Electrical Components and Equipment 1,664,960 1.0
Energy 3,340,425 2.0
Financial Services - Diversified 2,189,132 1.3
Healthcare Products and Services 257,864 0.2
Iron and Steel 1,742,108 1.0
Oil and Gas:
Ascent Energy 2,136 --
Oil and Gas - Other 2,613,243 1.6
Packaging and Containers 269,054 0.2
Publishing 52,797 --
Retail 6,826 --
Telecommunications 5,668,980 3.4
(Continued)
3
JEFFERIES PARTNERS OPPORTUNITY FUND II, LLC
Condensed Schedule of Investments
December 31, 2006
(Unaudited)
PERCENTAGE
OF MEMBERS'
Description FAIR VALUE EQUITY
------------------------------------------------------- ------------- ------------
Transportation 734,745 0.4%
------------ ------
Total United States 25,022,193 15.0
------------ ------
Total common stock 26,219,205 15.7
Preferred stock - United States:
Lodging $ 1,416 --%
Oil and Gas:
Ascent Energy 8% Series A Units 4,862,080 2.9
------------ ------
Total preferred stock - United States 4,863,496 2.9
Warrants - United States:
Healthcare Products and Services 28 --
Mining 1,200,000 0.7
Oil and Gas:
Ascent Energy 8% Series A Preferred 315,436 0.2
Telecommunications 24 --
Transportation 35 --
------------ ------
Total warrants - United States 1,515,523 0.9
Other holdings - United States
Escrow position - Chemicals 581,457 0.3
Escrow position - Electronics 59,611 --
Escrow position - Machinery 554,052 0.3
Investment Companies - Financial Services 721,890 0.4
Investment Companies - Oil and Gas 3,197,854 1.9
Trade Claim - Financial Services 429,276 0.3
------------ ------
Total other holdings - United States 5,544,140 3.3
------------ ------
Total securities owned $119,407,600 71.4%
============ ======
Securities sold, not yet purchased:
Corporate bonds:
Australia - Mining $ 172,432 0.1%
Bermuda:
Telecommunications 1,097,800 0.7
Transportation 82,792 --
------------ ------
Total Bermuda 1,180,592 0.7
Canada:
Iron and Steel 401,955 0.2
Oil and Gas 26,880 --
------------ ------
Total Canada 428,835 0.3
(Continued)
4
JEFFERIES PARTNERS OPPORTUNITY FUND II, LLC
Condensed Schedule of Investments
December 31, 2006
(Unaudited)
PERCENTAGE
OF MEMBERS'
Description FAIR VALUE EQUITY
------------------------------------------------------- ------------- ------------
France - Oil and Gas 110,550 0.1
Marshall Island - Transportation 294,250 0.2
Sweden - Holding Companies - Diversified 122,170 0.1
United States:
Aerospace and Defense 81,551 --
Auto Parts and Equipment 2,526,273 1.5
Coal 1,863,145 1.1
Commercial Services 382,963 0.2
Energy 7,920 --
Entertainment 2,909,105 1.7
Environmental Control 123,595 0.1
Financial Services - Diversified 16,481 --
Food 668,650 0.4
Healthcare Services 1,412,710 0.8
Home Builders 1,727,880 1.0
Household Products and Wares 643,732 0.4
Iron and Steel 1,307,001 0.8
Leisure Time 27,560 --
Lodging 2,008,335 1.2
Media 608,770 0.4
Metal Fabrication and Hardware 669,180 0.4
Mining 284,460 0.2
Miscellaneous Manufacturing 307,680 0.2
Office and Business Equipment 23,320 --
Oil and Gas 9,454,877 5.7
Packaging and Containers 94,600 0.1
Pharmaceuticals 112,132 0.1
REITS 206,000 0.1
Retail 1,486,744 0.9
Semiconductors 114,675 0.1
Telecommunications 559,402 0.3
------------ ------
Total United States 29,628,741 17.7
------------ ------
Total corporate bonds 31,937,570 19.1
Common stock - United States:
Oil and Gas 19,658 --
------------ ------
Total common stock - United States 19,658 --
------------ ------
Total securities sold, not yet purchased $ 31,957,228 19.1%
============ ======
See accompanying notes to financial statements
5
JEFFERIES PARTNERS OPPORTUNITY FUND II, LLC
Statement of Earnings
Year Ended December 31, 2006
(Unaudited)
Revenues:
Principal transactions, net of direct trading expenses (See note 5) 37,485,202
Interest:
Interest income 4,705,744
Interest expense (836,293)
------------
Net interest 3,869,451
------------
Net revenues 41,354,653
------------
Expenses:
General and administrative 680,120
Management fee (See note 5) 1,324,427
------------
Total expenses 2,004,547
------------
Net income $ 39,350,106
============
See accompanying notes to financial statements.
6
JEFFERIES PARTNERS OPPORTUNITY FUND II, LLC
Statement of Changes in Members' Equity
Year Ended December 31, 2006
(Unaudited)
TOTAL
CLASS B MEMBERS'
MEMBERS MEMBER EQUITY
------------- ------------- -------------
Balance, December 31, 2005 $ 162,962,886 1,000 162,963,886
Allocation of carried interest (4,974,974) 4,974,974 --
Distributions (30,128,644) (4,974,974) (35,103,618)
Net earnings 39,350,106 -- 39,350,106
------------- ------------- -------------
Balance, December 31, 2006 $ 167,209,374 1,000 167,210,374
============= ============= =============
See accompanying notes to financial statements.
7
JEFFERIES PARTNERS OPPORTUNITY FUND II, LLC
Statement of Cash Flows
Year Ended December 31, 2006
(Unaudited)
Cash flows from operating activities:
Net income $ 39,350,106
Adjustments to reconcile net earnings to net cash
used in operating activities:
Amortization of financing costs 107,644
Changes in operating assets and liabilities:
Increase in receivable from affiliated brokers and dealers (12,070,535)
Decrease in securities owned 25,471,200
Increase in securities borrowed (9,010,380)
Increase in other assets (138,748)
Increase in securities sold, not yet purchased 15,135,475
Increase in payable to affiliated brokers and dealers 1,360,562
Decrease in payable to Jefferies & Company, Inc. (287,060)
Increase in accrued expenses and other liabilities 360,831
------------
Net cash provided by operating activities 60,279,095
------------
Cash flows from financing activities:
Proceeds from bank loans 7,047,145
Repayment of bank loans (7,047,145)
Distributions (35,103,618)
------------
Net cash used in financing activities (35,103,618)
------------
Net increase in cash and cash equivalents 25,175,477
Cash and cash equivalents at beginning of year 24,076,728
------------
Cash and cash equivalents at end of year $ 49,252,205
============
Supplemental disclosures of cash flow information - Cash paid
during the year for interest $ 432,221
See accompanying notes to financial statements.
8
JEFFERIES PARTNERS OPPORTUNITY FUND II, LLC
Notes to Financial Statements
December 31, 2006
(Unaudited)
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Jefferies Partners Opportunity Fund II, LLC (the Fund) is a Delaware
limited liability company. The Fund commenced operations on January 19,
2000. The investment objective of the Fund is to generate returns for its
members by making, holding, and disposing of a diverse portfolio of
primarily below investment grade debt and equity investments. The Fund was
established to offer members the opportunity to participate in the
trading, investment, and brokerage activities of the High Yield Department
of Jefferies & Company, Inc. (Jefferies). The Fund employs a trading and
investment strategy substantially similar to that historically employed by
Jefferies' High Yield Department. The Fund acquires, actively manages, and
trades a diverse portfolio of primarily non-investment grade investments
consisting of the following three asset groups: High Yield Debt, Special
Situation Investments, and, to a lesser extent, Bank Loans. The Fund has
appointed Jefferies to serve as manager to the Fund (the Manager). The
Fund participates in the non-syndicate trading and investment activities
of the High Yield Department on a pari passu basis with Jefferies. To
permit such participation, the Fund has been registered as a broker dealer
under the Securities Exchange Act of 1934 and with the National
Association of Securities Dealers.
The Fund was due to terminate on January 18, 2007. The term of the Fund
was extended, as permitted, until January 18, 2008, unless extended for up
to two successive one-year terms by the vote of the Manager and a majority
of the member interests. (See note 8)
The Fund claims an exemption from Rule 15c3-3 as of December 31, 2006,
based on Section (k)(2)(ii). Securities transactions are cleared through
an affiliated broker-dealer on a fully disclosed basis. The Fund does not
execute any securities transactions with or on behalf of any customers.
The Fund prepares its financial statements in conformity with accounting
principles generally accepted in the United States of America (U.S. GAAP).
(a) CASH AND CASH EQUIVALENTS
Cash equivalents consist of money market funds, which are part of
the cash management activities of the Fund, and have original
maturities of 90 days or less. At December 31, 2006, such cash
equivalents amounted to $48,520,815.
(b) FAIR VALUE OF FINANCIAL INSTRUMENTS
Substantially all of the Fund's financial instruments are carried at
fair value or amounts approximating fair value. Assets, including
cash and cash equivalents, securities borrowed, and certain
receivables, are carried at fair value or contracted amounts which
approximate fair value due to the short period to maturity.
Similarly, liabilities, including certain payables, are carried at
amounts approximating fair value.
Securities and other inventory positions owned and securities and
other inventory positions sold, but not yet purchased (all of which
are recorded on a trade-date basis) are valued at fair value,, with
unrealized gains and losses reflected in Principal transactions in
the Statement of Earnings. Fair value generally is determined based
on listed prices or broker quotes. In certain instances, such price
quotations may be deemed unreliable when the instruments are thinly
traded and the listed price is not deemed to be readily realizable.
In these instances the Fund determines fair value based on
(Continued)
9
JEFFERIES PARTNERS OPPORTUNITY FUND II, LLC
Notes to Financial Statements
December 31, 2006
(Unaudited)
management's best estimate, giving appropriate consideration to
reported prices, the extent of public trading in similar securities
and the discount from the listed price associated with the cost at
the date of acquisition, among other factors. When listed prices or
broker quotes are not available, the Fund determines fair value
based on pricing models or other valuation techniques, including the
use of implied pricing from similar instruments. The Fund typically
uses pricing models to derive fair value based on the net present
value of estimated future cash flows including adjustments, when
appropriate, for liquidity, credit and/or other factors.
(c) SECURITIES TRANSACTIONS
The Fund records its securities transactions on a trade-date basis.
Securities owned and securities sold, not yet purchased, are valued
at fair value, and unrealized gains or losses are reflected in
Principal transactions in the Statements of Earnings.
(d) CONTRIBUTIONS
Capital contributions were recorded net of the Fund's closing costs
and placement fees. Each member is charged a one-time placement fee
of 1% of gross contributions.
(e) FEDERAL AND STATE INCOME TAXES
Under current federal and applicable state limited liability company
laws and regulations, limited liability companies are treated as
partnerships for tax reporting purposes and, accordingly, are not
subject to income taxes. Therefore, no provision for income taxes
has been made in the Fund's financial statements. For tax purposes,
income or losses are included in the tax returns of the members.
(f) ALLOCATION OF INCOME AND EXPENSE
Income and expense are allocated 100% to the members based on the
pro rata share of their capital contributed to the Fund until the
total allocation equals the aggregate members' preferred return of
8% of contributed capital. All remaining income and expense are
allocated 80% to the members and 20% to the Class B Member.
(g) USE OF ESTIMATES
The preparation of financial statements in conformity with U.S. GAAP
requires the Fund Manager to make a number of estimates and
assumptions relating to the reporting of assets and liabilities and
the disclosure of contingent assets and liabilities, and the
reported amounts of revenues and expenses to prepare these financial
statements. Actual results could differ from those estimates.
(h) NEW ACCOUNTING PRONOUNCEMENT
In September 2006, the Financial Accounting Standards Board released
Statement of Financial Accounting Standards No. 157 Fair Value
Measurements (FAS 157). FAS 157 establishes an authoritative
definition of fair value, sets out a framework for measuring fair
value, and requires additional disclosures about fair-value
measurements. The application of FAS 157 is required for fiscal
(Continued)
10
JEFFERIES PARTNERS OPPORTUNITY FUND II, LLC
Notes to Financial Statements
December 31, 2006
(Unaudited)
years beginning after November 15, 2007. Management is in the
process of assessing the impact of this standard on the financial
statements of the Fund.
(2) RECEIVABLE FROM, AND PAYABLE TO, AFFILIATED BROKERS AND DEALERS
The following is a summary of the major categories of receivable from, and
payable to, affiliated brokers and dealers as of December 31, 2006:
Receivable from affiliated brokers and dealers:
Securities failed to deliver $26,365,057
Other 1,315,003
-----------
$27,680,060
===========
Payable to affiliated brokers and dealers:
Securities failed to receive $17,520,265
(3) SECURITIES OWNED AND SECURITIES SOLD, NOT YET PURCHASED
The following is a summary of the fair value of major categories of
Securities owned and Securities sold, not yet purchased, as of December
31, 2006:
SECURITIES
SECURITIES SOLD, NOT YET
OWNED PURCHASED
------------ ------------
Corporate debt securities $ 81,265,236 31,937,570
Corporate equity securities 31,082,701 19,658
Other 7,059,663 --
------------ ------------
$119,407,600 31,957,228
============ ============
(4) REVOLVING CREDIT FACILITY
In June 2006, the Fund renewed a revolving credit facility agreement with
an unaffiliated third party to be used in connection with the Fund's
investing activities. At December 31, 2006, $85,200,000 was available
under the terms of the revolving credit facility agreement. The revolving
credit facility expires in June 2007, but provides for annual extensions.
Advances under this facility bear interest at the lender's commercial
paper rate plus 115 basis points. The Fund incurs a liquidity fee on the
total amount available under the revolving credit facility. The Fund
incurs a program fee on amounts borrowed under the revolving credit
facility. The Fund incurs a minimum program fee if program fees do not
reach a certain threshold. For the year ended December 31, 2006, the Fund
was charged a liquidity fee of $323,937, a program fee of $264,060 and an
administrative fee of $160, which are included in Interest expense in the
Statement of Earnings. During the year ended December 31, 2006, the Fund
borrowed, and subsequently repaid, $7,047,145 under the revolving credit
facility. For the year ended December 31, 2006, the Fund was charged
interest of $37,797 on balances borrowed under the revolving credit
facility. At December 31, 2006, there were no outstanding balances under
the revolving credit facility.
(Continued)
11
JEFFERIES PARTNERS OPPORTUNITY FUND II, LLC
Notes to Financial Statements
December 31, 2006
(Unaudited)
The Fund incurred costs in securing the revolving credit facility. These
costs have been capitalized and are being amortized over seven years. At
December 31, 2006, the net unamortized costs of $8,970 are included in
Other assets. For the year ended December 31, 2006, amortization expense
of $107,644 is included in Interest expense in the Statement of Earnings.
(5) RELATED PARTY TRANSACTIONS
At December 31, 2006, members' equity included an investment in the Fund
by Jefferies of $27,159,268. Additionally, Jefferies, as the Class B
Member, contributed $1,000 of capital for the right to receive a
distribution of 20% of the Fund's distributions in excess of an 8%
preferred return paid to the members. During the year ended December 31,
2006, the Fund distributed, in cash, undistributed net income of
$35,103,618 to the members, of which $4,974,974 was distributed to the
Class B Member in accordance with its carried interest.
At December 31, 2006, receivable from and payable to affiliated brokers
and dealers are for amounts due from and due to Jefferies related to trade
execution and settlement. (See note 2)
For the year ended December 31, 2006, interest income included $289,079 of
income received from Jefferies Execution Services, Inc. related to stock
borrow transactions. During the year ended December 31, 2006, Jefferies
Execution Services, Inc. was the sole counterparty to all of the Fund's
stock borrow transactions. At December 31, 2006, Payable to Jefferies &
Company, Inc. of $252,532 is for amounts due for direct trading expenses,
general and administrative expenses, and management fees. For the year
ended December 31, 2006, direct trading expenses of $3,627,182 is netted
against principal transactions revenue. The Fund reimburses Jefferies for
general and administrative expenses based on the Fund's pro rata portion
of actual charges incurred. For the year ended December 31, 2006,
reimbursed expenses of $522,212 are included in General and administrative
expenses.
For the year ended December 31, 2006, the Fund was charged interest of
$102,695 by Jefferies related to securities failed to receive.
Jefferies, in its capacity as Manager, receives a management fee equal to
1% per annum of the sum of 100% of the average balance of securities owned
and 98% of the average balance of securities sold, not yet purchased. At
December 31, 2006, accrued management fees of $117,844 were included in
Payable to Jefferies & Company, Inc.
(6) FINANCIAL INSTRUMENTS
(a) OFF-BALANCE SHEET RISK
The Fund has contractual commitments arising in the ordinary course
of business for securities sold, not yet purchased. These financial
instruments contain varying degrees of off-balance sheet risk
whereby the fair values of the securities underlying the financial
instruments may be in excess of, or less than, the contract amount.
The settlement of these transactions is not expected to have a
material effect upon the Fund's financial statements.
(Continued)
12
JEFFERIES PARTNERS OPPORTUNITY FUND II, LLC
Notes to Financial Statements
December 31, 2006
(Unaudited)
(b) CREDIT RISK
In the normal course of business, the Fund is involved in the
execution, settlement, and financing of various principal securities
transactions. Securities transactions are subject to the risk of
counterparty nonperformance. However, transactions are
collateralized by the underlying security, thereby reducing the
associated risk to changes in the fair value of the security through
settlement date.
The Fund seeks to control the risk associated with these
transactions by establishing and monitoring collateral and
transaction levels daily.
(c) CONCENTRATION OF CREDIT RISK
The Fund's activities are executed exclusively with Jefferies.
Concentrations of credit risk can be affected by changes in
economic, industry, or geographical factors. The Fund seeks to
control its credit risk and the potential risk concentration through
a variety of reporting and control procedures including those
described in the preceding discussion of credit risk.
(7) NET CAPITAL REQUIREMENT
The Fund is subject to the Securities and Exchange Commission Uniform Net
Capital Rule (Rule 15c3-1), which requires the maintenance of minimum net
capital. The Fund has elected to use the alternative method permitted by
Rule 15c3-1, which requires that the Fund maintain minimum net capital, as
defined, equal to the greater of $250,000 or 2% of aggregate debit
balances arising from customer transactions, as defined.
At December 31, 2006, the Fund had net capital of $90,891,025, which was
$90,641,025 in excess of required net capital.
(8) SUBSEQUENT EVENTS
On January 15, 2007, the Manager and a majority of the member interests
elected to extend the Fund's term until January 18, 2008. The Fund will be
in effect until January 18, 2008, unless extended for up to two successive
one-year terms by the vote of the Manager and a majority of the member
interests.
On February 15, 2007, the Fund distributed, in cash, undistributed net
income of $39,350,106 to the members, of which $5,824,273 was distributed
to the Class B Member in accordance with its carried interest.
13
JEFFERIES PARTNERS OPPORTUNITY FUND II, LLC
Financial Statements
As of December 31, 2005
and for the year then ended
(With Independent Auditors' Report Thereon)
REPORT OF THE INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
-----------------------------------------------------------
The Members
Jefferies Partners Opportunity Fund II, LLC:
We have audited the accompanying statement of financial condition of Jefferies
Partners Opportunity Fund II, LLC (the "Fund"), including the condensed schedule
of investments, as of December 31, 2005, and the related statements of earnings,
changes in members' equity, and cash flows for the year then ended. These
financial statements are the responsibility of the Fund's management. Our
responsibility is to express an opinion on these financial statements based on
our audit.
We conducted our audit in accordance with standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Jefferies Partners Opportunity
Fund II, LLC as of December 31, 2005, and the results of its operations and its
cash flows for the year then ended in conformity with U.S. generally accepted
accounting principles.
/s/ KPMG LLP
New York, New York
February 28, 2006
JEFFERIES PARTNERS OPPORTUNITY FUND II, LLC
Statement of Financial Condition
December 31, 2005
ASSETS
Cash and cash equivalents $ 24,076,728
Receivable from affiliated brokers and dealers 15,609,525
Securities owned 144,878,800
Securities borrowed 11,271,700
Other assets 724,538
-------------------
Total assets $ 196,561,291
===================
LIABILITIES AND MEMBERS' EQUITY
Securities sold, not yet purchased $ 16,821,753
Payable to affiliated brokers and dealers 16,159,703
Payable to Jefferies & Company, Inc. 539,592
Accrued expenses and other liabilities 76,357
-------------------
Total liabilities 33,597,405
-------------------
Members' equity: 162,963,886
-------------------
Total liabilities and members' equity $ 196,561,291
===================
See accompanying notes to financial statements.
2
JEFFERIES PARTNERS OPPORTUNITY FUND II, LLC
Condensed Schedule of Investments
December 31, 2005
PERCENTAGE OF
MEMBERS'
DESCRIPTION FAIR VALUE EQUITY
--------------------------------------------------------------------------- -------------------- -------------------
Securities owned:
Corporate Bonds:
Bermuda - Transportation $ 1,537,515 0.9%
British Virgin Islands - Oil & Gas 537,600 0.3%
Canada:
Engineering & Construction 351,540 0.2%
Oil & Gas 266,520 0.2%
Transportation 73,260 0.0%
-------------------- -------------------
Total Canada 691,320 0.4%
-------------------- -------------------
Cayman Islands - Oil & Gas 6,000 0.0%
France - Oil & Gas 6,240 0.0%
Luxembourg - Telecommunications 125,400 0.1%
Norway - Oil & Gas 353,100 0.2%
Sweden - Holding Companies - Diversified 54,000 0.0%
United States:
Aerospace & Defense 48,000 0.0%
Agriculture 2,019,750 1.2%
Airlines 1,353,514 0.8%
Apparel 873,038 0.5%
Auto Parts & Equipment 2,388,170 1.5%
Biotechnology 70,920 0.0%
Building Materials 315,630 0.2%
Chemicals 47,040 0.0%
Coal 487,785 0.3%
Commercial Services 772,681 0.5%
Cosmetics & Personal Care 37,440 0.0%
Electrical Components & Equipment 393,500 0.2%
Electronics 8,738,006 5.4%
Engineering & Construction 389,760 0.2%
Entertainment 31,076 0.0%
Environmental Control 93,150 0.1%
Financial Services - Diversified 239,705 0.1%
Food 747 0.0%
Healthcare Services 3,880 0.0%
3 (Continued)
JEFFERIES PARTNERS OPPORTUNITY FUND II, LLC
Condensed Schedule of Investments
December 31, 2005
PERCENTAGE OF
MEMBERS'
DESCRIPTION FAIR VALUE EQUITY
--------------------------------------------------------------------------- -------------------- -------------------
Holding Companies-Diversified 1,665,129 1.0%
Home Builders 50,880 0.0%
Iron & Steel 5,415,836 3.3%
Leisure Time 1,577,025 1.0%
Lodging 7,026,360 4.3%
Media 548,520 0.3%
Metal Fabrication & Hardware 2,631,778 1.6%
Mining 508,963 0.3%
Miscellaneous Manufacturing 5,466,885 3.4%
Oil & Gas:
Ascent Energy 11.75% 5/1/15 15,706,374 9.6%
Texcal Energy Ser A Units 31,644,800 19.4%
Oil & Gas - Other 9,116,942 5.6%
Packaging & Containers 1,306,840 0.8%
Retail 692,825 0.4%
Telecommunications 4,725,802 2.9%
Textiles 12 0.0%
Transportation 77,780 0.0%
-------------------- -------------------
Total United States 106,466,543 65.3%
-------------------- -------------------
Total corporate bonds 109,777,718 67.4%
-------------------- -------------------
Common Stock:
Canada - Airlines 2,840,976 1.7%
Great Britain - Telecommunications 3,260,208 2.0%
United States:
Auto Parts & Equipment 55,440 0.0%
Beverages 1,493,796 0.9%
Chemicals 3,867,942 2.4%
Commercial Services 5,067,728 3.1%
Distribution - Wholesale 197,086 0.1%
Electrical Components & Equipment 8,316 0.0%
Electronics 742,323 0.5%
Financial Services - Diversified 2,375,674 1.5%
Iron & Steel 1,176,480 0.7%
Machinery:
Fairfield Manufacturing 12,861,600 7.9%
Publishing 57,595 0.0%
4 (Continued)
JEFFERIES PARTNERS OPPORTUNITY FUND II, LLC
Condensed Schedule of Investments
December 31, 2005
PERCENTAGE OF
MEMBERS'
DESCRIPTION FAIR VALUE EQUITY
--------------------------------------------------------------------------- -------------------- -------------------
Retail 7,422 0.0%
Telecommunications 172,998 0.1%
Textiles 2,605 0.0%
-------------------- -------------------
Total United States 28,087,005 17.2%
-------------------- -------------------
Total common stock 34,188,189 21.0%
-------------------- -------------------
Warrants:
United States 27,125 0.0%
-------------------- -------------------
Investment Companies
United States 885,768 0.5%
-------------------- -------------------
Total securities owned $ 144,878,800 88.9%
==================== ===================
Securities sold, not yet purchased:
Corporate Bonds:
Canada:
Electrical Components & Equipment $ 257,720 0.2%
Financial Services - Diversified 195,020 0.1%
Forest Products & Paper 27,863 0.0%
Iron & Steel 604,800 0.4%
Mining 218,400 0.1%
-------------------- -------------------
Total Canada 1,303,803 0.8%
-------------------- -------------------
Marshall Island - Transportation 97,920 0.1%
United States:
Aerospace & Defense 371,870 0.2%
Auto Parts & Equipment 300,600 0.2%
Building Materials 9,950 0.0%
Coal 1,457,505 0.9%
Commercial Services 11,400 0.0%
Electrical Components & Equipment 3,510 0.0%
Electronics 251,548 0.2%
Entertainment 646,010 0.4%
Environmental Control 57,600 0.0%
Financial Services - Diversified 83,270 0.1%
Food 174,100 0.1%
Forest Products & Paper 546,000 0.3%
5 (Continued)
JEFFERIES PARTNERS OPPORTUNITY FUND II, LLC
Condensed Schedule of Investments
December 31, 2005
PERCENTAGE OF
MEMBERS'
DESCRIPTION FAIR VALUE EQUITY
--------------------------------------------------------------------------- -------------------- -------------------
Healthcare Services 725,400 0.4%
Household Products & Wares 571,825 0.4%
Iron & Steel 630,470 0.4%
Lodging 2,124,518 1.3%
Media 125,495 0.1%
Metal Fabrication & Hardware 626,830 0.4%
Mining 638,280 0.4%
Miscellaneous Manufacturing 138,600 0.1%
Oil & Gas 3,226,374 2.0%
Packaging & Containers 418,860 0.3%
Pharmaceuticals 122,400 0.1%
Retail 1,306,737 0.8%
Telecommunications 337,773 0.2%
Transportation 511,665 0.3%
-------------------- -------------------
Total United States 15,418,590 9.5%
-------------------- -------------------
Total corporate bonds 16,820,313 10.3%
-------------------- -------------------
Warrants:
United States 1,440 0.0%
-------------------- -------------------
Total securities sold, not yet purchased $ 16,821,753 10.3%
==================== ===================
See accompanying notes to financial statements.
6
JEFFERIES PARTNERS OPPORTUNITY FUND II, LLC
Statement of Earnings
Year ended December 31, 2005
Revenues:
Principal transactions, net of direct trading
expenses (See Note 5) $ 33,330,000
Interest:
Interest income 4,120,287
Interest expense (757,797)
-------------------
Net interest 3,362,490
-------------------
Net revenues 36,692,490
-------------------
Expenses:
General and administrative 473,117
Management fee 1,115,755
-------------------
Total expenses 1,588,872
-------------------
Net income $ 35,103,618
===================
See accompanying notes to financial statements.
7
JEFFERIES PARTNERS OPPORTUNITY FUND II, LLC
Statement of Changes in Members' Equity
Year ended December 31, 2005
TOTAL
CLASS B MEMBERS'
MEMBERS MEMBER EQUITY
------------------ ------------------ ------------------
Balance, December 31, 2004 $ 151,260,161 $ 1,000 $ 151,261,161
Allocation of carried interest (2,634,430) 2,634,430 --
Distributions (20,766,463) (2,634,430) (23,400,893)
Net earnings 35,103,618 -- 35,103,618
------------------ ------------------ ------------------
Balance, December 31, 2005 $ 162,962,886 $ 1,000 $ 162,963,886
================== ================== ==================
See accompanying notes to financial statements.
8
JEFFERIES PARTNERS OPPORTUNITY FUND II, LLC
Statement of Cash Flows
Year ended December 31, 2005
Cash flows from operating activities:
Net income
Adjustments to reconcile net earnings to net cash used in operating activities: $ 35,103,618
Amortization of financing costs 107,644
Changes in operating assets and liabilities:
Decrease in receivable from affiliated brokers and dealers 4,289,054
Increase in securities owned (66,448,299)
Increase in securities borrowed (9,948,630)
Increase in other assets (178,919)
Increase in securities sold, not yet purchased 13,316,236
Increase in payable to affiliated brokers and dealers 12,547,779
Increase in payable to Jefferies & Company, Inc. 179,189
Decrease in accrued expenses and other liabilities (423,875)
-------------------
Net cash used in operating activities (11,456,203)
-------------------
Cash flows from financing activities:
Distributions (23,400,893)
-------------------
Net cash used in financing activities (23,400,893)
-------------------
Net decrease in cash and cash equivalents (34,857,096)
Cash and cash equivalents at beginning of year 58,933,824
-------------------
Cash and cash equivalents at end of year $ 24,076,728
===================
Supplemental disclosures of cash flow information - Cash paid
during the year for interest $ 876,497
See accompanying notes to financial statements.
9
JEFFERIES PARTNERS OPPORTUNITY FUND II, LLC
Notes to Financial Statements
Year ended December 31, 2005
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Jefferies Partners Opportunity Fund II, LLC (the "Fund") is a Delaware
limited liability company. The Fund commenced operations on January 19,
2000. The investment objective of the Fund is to generate returns for its
members by making, holding, and disposing of a diverse portfolio of
primarily below investment grade debt and equity investments. The Fund was
established to offer members the opportunity to participate in the trading,
investment, and brokerage activities of the High Yield Department of
Jefferies & Company, Inc. ("Jefferies"). The Fund employs a trading and
investment strategy substantially similar to that historically employed by
Jefferies' High Yield Department. The Fund acquires, actively manages, and
trades a diverse portfolio of primarily non-investment grade investments
consisting of the following three asset groups: High Yield Debt, Special
Situation Investments, and, to a lesser extent, Bank Loans. The Fund has
appointed Jefferies to serve as manager to the Fund (the "Manager"). The
Fund participates in the non-syndicate trading and investment activities of
the High Yield Department on a pari passu basis with Jefferies. To permit
such participation, the Fund has been registered as a broker dealer under
the Securities Exchange Act of 1934 and with the National Association of
Securities Dealers.
The Fund will be in effect until January 18, 2007, unless extended for up
to three successive one-year terms by the vote of the Manager and a
majority of the member interests.
The Fund claims an exemption from Rule 15c3-3 as of December 31, 2005,
based on Section (k)(2)(ii). Securities transactions are cleared through an
affiliated broker-dealer on a fully disclosed basis. The Fund does not
execute any securities transactions with or on behalf of any customers.
The Fund prepares its financial statements in conformity with accounting
principles generally accepted in the United States of America ("U.S.
GAAP").
(a) CASH AND CASH EQUIVALENTS
Cash equivalents consist of money market funds, which are part of the
cash management activities of the Fund, and have original maturities
of 90 days or less. At December 31, 2005, such cash equivalents
amounted to $23,589,985.
(b) FAIR VALUE OF FINANCIAL INSTRUMENTS
Substantially all of the Fund's financial instruments are carried at
fair value or amounts approximating fair value. Assets, including cash
and cash equivalents, securities borrowed, and certain receivables,
are carried at fair value or contracted amounts which approximate fair
value due to the short period to maturity. Similarly, liabilities,
including certain payables, are carried at amounts approximating fair
value.
Securities and other inventory positions owned and securities and
other inventory positions sold, but not yet purchased (all of which
are recorded on a trade-date basis) are valued at fair value, with
unrealized gains and losses reflected in Principal transactions in the
Statement of Earnings. Fair value generally is determined based on
listed prices or broker quotes. In certain instances, such price
quotations may be deemed unreliable when the instruments are thinly
traded or when the Fund holds a substantial block of a particular
security and the listed price is not deemed to be readily realizable.
In these instances, the Fund determines fair value based on
management's best estimate, giving appropriate consideration to
10 (Continued)
JEFFERIES PARTNERS OPPORTUNITY FUND II, LLC
Notes to Financial Statements
December 31, 2005
reported prices and the extent of public trading in similar
securities, the discount from the listed price associated with the
cost at the date of acquisition, and the size of the position held in
relation to the liquidity in the market, among other factors. When the
size of the holding of a listed security is likely to impair the
Fund's ability to realize the quoted market price, the Fund records
the position at a discount to the quoted price reflecting management's
best estimate of fair value. In such instances, the Fund generally
determines fair value with reference to the discount associated with
the acquisition price of the security. When listed prices or broker
quotes are not available, the Fund determines fair value based on
pricing models or other valuation techniques, including the use of
implied pricing from similar instruments. The Fund typically uses
pricing models to derive fair value based on the net present value of
estimated future cash flows including adjustments, when appropriate,
for liquidity, credit and/or other factors.
(c) SECURITIES TRANSACTIONS
The Fund records its securities transactions on a trade-date basis.
Securities owned and securities sold, not yet purchased, are valued at
fair value, and unrealized gains or losses are reflected in Principal
transactions in the Statements of Earnings.
(d) CONTRIBUTIONS
Capital contributions were recorded net of the Fund's closing costs
and placement fees. Each member is charged a one-time placement fee of
1% of gross contributions.
(e) FEDERAL AND STATE INCOME TAXES
Under current federal and applicable state limited liability company
laws and regulations, limited liability companies are treated as
partnerships for tax reporting purposes and, accordingly, are not
subject to income taxes. Therefore, no provision for income taxes has
been made in the Fund's financial statements. For tax purposes, income
or losses are included in the tax returns of the members.
(f) ALLOCATION OF INCOME AND EXPENSE
Income and expense are allocated 100% to the members based on the pro
rata share of their capital contributed to the Fund until the total
allocation equals the aggregate members' preferred return of 8% of
contributed capital. All remaining income and expense are allocated
80% to the members and 20% to the Class B Member.
(g) COMMITMENTS
As of December 31, 2005, the Fund had unfunded commitments of
$2,760,000 under a revolving credit facility.
11 (Continued)
JEFFERIES PARTNERS OPPORTUNITY FUND II, LLC
Notes to Financial Statements
December 31, 2005
(h) USE OF ESTIMATES
The preparation of financial statements in conformity with U.S. GAAP
requires the Fund Manager to make a number of estimates and
assumptions relating to the reporting of assets and liabilities, the
disclosure of contingent assets and liabilities, and the reported
amounts of revenues and expenses to prepare these financial
statements. Actual results could differ from those estimates.
(2) RECEIVABLE FROM, AND PAYABLE TO, AFFILIATED BROKERS AND DEALERS
The following is a summary of the major categories of receivable from, and
payable to, affiliated brokers and dealers as of December 31, 2005:
Receivable from affiliated brokers and dealers:
Securities failed to deliver $ 15,581,273
Other 28,252
----------------
$ 15,609,525
================
Payable to affiliated brokers and dealers:
Securities failed to receive $ 14,972,987
Other 1,186,716
----------------
$ 16,159,703
================
(3) SECURITIES OWNED AND SECURITIES SOLD, NOT YET PURCHASED
The following is a summary of the fair value of major categories of
Securities owned and Securities sold, not yet purchased, as of December 31,
2005:
SECURITIES
SECURITIES SOLD, NOT YET
OWNED PURCHASED
----------------- -----------------
Corporate debt securities $ 109,777,718 $ 16,820,313
Corporate equity securities 34,215,314 1,440
Other 885,768 --
----------------- -----------------
$ 144,878,800 $ 16,821,753
================= =================
(4) REVOLVING CREDIT FACILITY
In June 2005, the Fund renewed a revolving credit facility agreement with
an unaffiliated third party to be used in connection with the Fund's
investing activities. At December 31, 2005, $85,200,000 was available under
the terms of the revolving credit facility agreement. The revolving credit
facility expires in June 2006, but provides for annual extensions. Advances
under this facility bear interest at the lender's commercial paper rate
plus 115 basis points. The Fund incurs a liquidity fee on the total amount
available under the revolving credit facility. The Fund incurs a program
fee on amounts borrowed under the revolving credit facility. The Fund
incurs a minimum program fee if program fees do not reach a certain
threshold. For the year ended December 31, 2005, the Fund was charged a
12 (Continued)
JEFFERIES PARTNERS OPPORTUNITY FUND II, LLC
Notes to Financial Statements
December 31, 2005
liquidity fee of $323,938 and a program fee of $257,304, which are included
in Interest expense in the Statement of Earnings. During the year ended
December 31, 2005, the Fund did not borrow under the revolving credit
facility. At December 31, 2005, there were no outstanding balances under
the revolving credit facility.
The Fund incurred costs in securing the revolving credit facility. These
costs have been capitalized and are being amortized over seven years. At
December 31, 2005, the net unamortized costs of $116,614 are included in
Other assets. For the year ended December 31, 2005, amortization expense of
$107,644 is included in Interest expense in the Statement of Earnings.
(5) RELATED PARTY TRANSACTIONS
At December 31, 2005, members' equity included an investment in the Fund by
Jefferies of $27,159,268. Additionally, Jefferies, as the Class B Member,
contributed $1,000 of capital for the right to receive a distribution of
20% of the Fund's distributions in excess of an 8% preferred return paid to
the members. During the year ended December 31, 2005, the Fund distributed,
in cash, undistributed net income of $23,400,893 to the members, of which
$2,634,430 was distributed to the Class B Member in accordance with its
carried interest.
At December 31, 2005, receivable from and payable to affiliated brokers and
dealers are for amounts due from and due to Jefferies related to trade
execution and settlement.
For the year ended December 31, 2005, interest income included $38,263 of
income received from Jefferies Execution Services, Inc. related to stock
borrow transactions. During the year ended December 31, 2005, Jefferies
Execution Services, Inc. was the sole counterparty to all of the Fund's
stock borrow transactions.
At December 31, 2005, Payable to Jefferies & Company, Inc. of $539,592 is
for amounts due for direct trading expenses, general and administrative
expenses, and management fees. For the year ended December 31, 2005, direct
trading expenses of $3,005,998 is netted against principal transactions
revenue. The Fund reimburses Jefferies for general and administrative
expenses based on the Fund's pro rata portion of actual charges incurred.
For the year ended December 31, 2005, reimbursed expenses of $506,228 are
included in General and administrative expenses.
For the year ended December 31, 2005, the Fund was charged interest of
$68,912 by Jefferies related to securities failed to receive.
Jefferies, in its capacity as Manager, receives a management fee equal to
1% per annum of the sum of 100% of the average balance of securities owned
and 98% of the average balance of securities sold, not yet purchased. At
December 31, 2005, accrued management fees of $129,202 were included in
Payable to Jefferies & Company, Inc.
13 (Continued)
JEFFERIES PARTNERS OPPORTUNITY FUND II, LLC
Notes to Financial Statements
December 31, 2005
(6) FINANCIAL INSTRUMENTS
(a) OFF-BALANCE SHEET RISK
The Fund has contractual commitments arising in the ordinary course of
business for securities sold, not yet purchased. These financial
instruments contain varying degrees of off-balance sheet risk whereby
the fair values of the securities underlying the financial instruments
may be in excess of, or less than, the contract amount. The settlement
of these transactions is not expected to have a material effect upon
the Fund's financial statements.
(b) CREDIT RISK
In the normal course of business, the Fund is involved in the
execution, settlement, and financing of various principal securities
transactions. Securities transactions are subject to the risk of
counterparty nonperformance. However, transactions are collateralized
by the underlying security, thereby reducing the associated risk to
changes in the fair value of the security through settlement date.
The Fund seeks to control the risk associated with these transactions
by establishing and monitoring collateral and transaction levels
daily.
(c) CONCENTRATION OF CREDIT RISK
The Fund's activities are executed exclusively with Jefferies.
Concentrations of credit risk can be affected by changes in economic,
industry, or geographical factors. The Fund seeks to control its
credit risk and the potential risk concentration through a variety of
reporting and control procedures including those described in the
preceding discussion of credit risk.
(7) NET CAPITAL REQUIREMENT
The Fund is subject to the Securities and Exchange Commission Uniform Net
Capital Rule (Rule 15c3-1), which requires the maintenance of minimum net
capital. The Fund has elected to use the alternative method permitted by
Rule 15c3-1, which requires that the Fund maintain minimum net capital, as
defined, equal to the greater of $250,000 or 2% of aggregate debit balances
arising from customer transactions, as defined.
At December 31, 2005, the Fund had net capital of $51,434,728, which was
$51,184,728 in excess of required net capital.
(8) SUBSEQUENT EVENT
On February 15, 2006, the Fund distributed, in cash, undistributed net
income of $35,103,618 to the members, of which $4,974,974 was distributed
to the Class B Member in accordance with its carried interest.
14
FINANCIAL STATEMENTS
Pershing Square IV, L.P.
Period from June 1, 2007 (commencement of operations) to December 31, 2007 with
Report of Independent Registered Public Accounting Firm
Pershing Square IV, L.P.
Financial Statements
Period from June 1, 2007 (commencement of operations) to December 31, 2007
CONTENTS
Audited Financial Statement Schedules Index
Report of Independent Registered Public Accounting Firm ................. 1
Statement of Assets, Liabilities and Partners' Capital .................. 2
Statement of Operations.................................................. 3
Statement of Changes in Partners' Capital ............................... 4
Statement of Cash Flows ................................................. 5
Notes to Financial Statements ........................................... 6
Financial Statements of Pershing Square IV A, L.P.
Report of Independent Registered Public Accounting Firm
The General Partner
Pershing Square IV, L.P.
We have audited the accompanying statement of asset, liabilities and partners'
capital of Pershing Square IV, L.P. (the "Partnership") as of December 31, 2007,
and the related statements of operations, changes in partners' capital and cash
flows for the period from June 1, 2007 (commencement of operations) to December
31, 2007. These financial statements are the responsibility of the Partnership's
management. Our responsibility is to express an opinion on these financial
statements based on our audit.
We conducted our audit in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. We were not engaged to perform an
audit of the Partnership's internal control over financial reporting. Our audit
included consideration of internal control over financial reporting as a basis
for designing audit procedures that are appropriate in the circumstances, but
not for the purpose of expressing an opinion on the effectiveness of the
Partnership's internal control over financial reporting. Accordingly, we express
no such opinion. An audit also includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Pershing Square IV, L.P. at
December 31, 2007, and the results of its operations, the changes in its
partners' capital and its cash flows for the period from June 1, 2007
(commencement of operations) to December 31, 2007, in conformity with accounting
principles generally accepted in the United States of America.
/s/ ERNST & YOUNG
March 19, 2008
1
Pershing Square IV, L.P.
Statement of Assets, Liabilities and Partners' Capital
(Stated in United States Dollars)
December 31, 2007
ASSETS
Investment in Pershing Square IV A, L.P. $1,127,674,674
--------------
Total assets $1,127,674,674
==============
LIABILITIES AND PARTNERS' CAPITAL
Accrued expenses $ 44,961
Withholding tax payable 19,870
--------------
Total liabilities 64,831
Partners' capital 1,127,609,843
--------------
Total liabilities and partners' capital $1,127,674,674
==============
The accompanying notes and attached consolidated financial statements of
Pershing Square IV A, L.P. are an integral part of the financial statements.
2
Pershing Square IV, L.P.
Statement of Operations
(Stated in United States Dollars)
Period from June 1, 2007 (commencement of operations) to December 31, 2007
NET REALIZED AND UNREALIZED LOSSES ALLOCATED
FROM INVESTMENT IN PERSHING SQUARE IV A, L.P.
Net realized loss from investments in $ (40,790,512)
securities
Net change in unrealized loss from
investments in securities (722,016,297)
Net realized loss on derivative contracts (93,937,016)
Net change in unrealized loss on derivative (517,824)
contracts --
Net loss allocated from investment in
Pershing Square IV A, L.P. $(857,261,649)
NET INVESTMENT INCOME ALLOCATED FROM
INVESTMENT IN
PERSHING SQUARE IV A, L.P.
INVESTMENT INCOME
Interest 18,557,238
Dividends 383,405
Total expenses (4,104,320)
-------------
Net investment income allocated from
investment in Pershing Square IV A, L.P. 14,836,323
PARTNERSHIP EXPENSES
Professional fees (44,961)
Withholding tax (19,870)
-------------
Total expenses (64,831)
-------------
-------------
Net investment income 14,771,492
-------------
Net loss $(842,490,157)
=============
The accompanying notes and attached consolidated financial statements of
Pershing Square IV A, L.P. are an integral part of the financial statements.
3
Pershing Square IV, L.P.
Statement of Changes in Partners' Capital
(Stated in United States Dollars)
Period from June 1, 2007 (commencement of operations) to December 31, 2007
Limited partners capital contributions $ 1,970,100,000
Net loss (842,490,157)
---------------
Partners' capital at end of period $ 1,127,609,843
===============
The accompanying notes and attached consolidated financial statements of
Pershing Square IV A, L.P. are an integral part of the financial statements.
4
Pershing Square IV, L.P.
Statement of Cash Flows
(Stated in United States Dollars)
Period from June 1, 2007 (commencement of operations) to December 31, 2007
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $ (842,490,157)
Adjustments to reconcile net loss to net cash used in
operating activities:
Increase in investment in Pershing Square IV A, L.P. (1,127,674,674)
Increase in accrued expenses 44,961
Increase in withholding tax payable 19,870
---------------
Net cash used in operating activities (1,970,100,000)
CASH FLOWS FROM FINANCING ACTIVITIES
Capital contributions 1,970,100,000
---------------
Net change in cash and cash equivalents --
Cash and cash equivalents at beginning of period --
---------------
Cash and cash equivalents at end of period $ --
===============
The accompanying notes and attached consolidated financial statements of
Pershing Square IV A, L.P. are an integral part of the financial statements.
5
Pershing Square IV, L.P.
Notes to Financial Statements
December 31, 2007
1. ORGANIZATION
Pershing Square IV, L.P. (the "Partnership") is organized as a limited
partnership under the laws of the state of Delaware on May 22, 2007 and
commenced operations on June 1, 2007. The objective of the Partnership is to
invest all of its assets in Pershing Square IV A, L.P. (the "Subsidiary
Partnership"). The Subsidiary Partnership is an exempted limited partnership
formed under the limited liability partnership laws of the Cayman Islands on May
31, 2007 and commenced operations on June 1, 2007. The investment objective of
the Partnership and the Subsidiary Partnership (collectively, the "PSIV
Partnerships") is to create significant capital appreciation by investing in
stock, total return swaps and call options of Target Corporation.
The Partnership is a "master" fund in a "master-feeder" structure whereby
Pershing Square International IV, Ltd. (the "Fund") invests all of its assets in
the Partnership. The Partnership is also a "feeder" fund in a "master-feeder"
structure as the Partnership invests all of its assets in the Subsidiary
Partnership.
Pershing Square Holdings GP, LLC, a limited liability company organized under
the laws of the state of Delaware and registered as a foreign company under the
laws of the Cayman Islands, will serve as the "General Partner" to the PSIV
Partnerships. The General Partner is responsible for making all investment
decisions on behalf of the PSIV Partnerships and is solely responsible for the
development and implementation of the PSIV Partnerships' investment policy and
strategy. William A. Ackman is the managing member of the General Partner and is
primarily responsible for managing the PSIV Partnerships.
The General Partner delegates administrative functions relating to the
management of the PSIV Partnerships to Pershing Square Capital Management, L.P.
("PSCM"), a limited partnership organized under the laws of the state of
Delaware. William A. Ackman is the managing member of the general partner of
PSCM.
Pursuant to an Administration Agreement entered into in May 2007, Goldman Sachs
(Cayman) Trust, Limited (the "Administrator") has been appointed administrator
to the PSIV Partnerships. The Administrator is compensated for its services in
accordance with the fees stated in this Administration Agreement.
6
Pershing Square IV, L.P.
Notes to Financial Statements (continued)
2. SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The financial statements of the Partnership have been prepared in accordance
with accounting principles generally accepted in the United States of America
and are stated in United States dollars. The following is a summary of the
significant accounting and reporting policies used in preparing the financial
statements.
CASH AND CASH EQUIVALENTS
The Partnership considers all highly liquid financial instruments with a
maturity of three months or less to be cash equivalents.
VALUATION OF INVESTMENT IN THE SUBSIDIARY PARTNERSHIP
The Partnership's investment in the Subsidiary Partnership is valued at fair
value, which represents the Partnership's proportionate interest in the
partners' capital of the Subsidiary Partnership at December 31, 2007, determined
from audited financial statements prepared in accordance with accounting
principles generally accepted in the United States. The performance of the
Partnership is directly affected by the performance of the Subsidiary
Partnership. Attached are the audited financial statements of the Subsidiary
Partnership, including the consolidated condensed schedule of investments and
significant accounting and reporting policies, which are an integral part of
these financial statements. Valuation of the investment held by the Partnership
is discussed in the notes of the Subsidiary Partnership's financial statements.
As of December 31, 2007, the Partnership has approximately 99.95% ownership
interest in the Subsidiary Partnership.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The fair value of the Partnership's assets and liabilities, which qualify as
financial instruments under Statement of Financial Accounting Standards No. 107,
"Disclosures About Fair Value of Financial Instruments," approximates the
carrying amounts presented in the statement of assets, liabilities and partners'
capital.
INVESTMENT TRANSACTIONS AND RELATED INVESTMENT INCOME
The Partnership records its investment transactions and the related revenue and
expenses on a trade-date basis. All unrealized gains and losses from the
Partnership's investment in the Subsidiary Partnership are reflected in the
statement of operations.
7
Pershing Square IV, L.P.
Notes to Financial Statements (continued)
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
USE OF ESTIMATES
The preparation of the financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the amounts reported in
the financial statements and accompanying notes. Actual results could differ
from those estimates.
TAXATION
No Federal, state or local income taxes have been provided on income or loss of
the Partnership since the partners are individually liable for the taxes on
their share of the Partnership's income or loss. The only taxes payable by the
Partnership on its income are withholding taxes applicable to certain investment
income. As a result, no income tax liability or expense has been recorded in the
accompanying financial statements.
NEW ACCOUNTING PRONOUNCEMENTS
On July 13, 2006, the Financial Accounting Standards Board ("FASB") released
FASB Interpretation No. 48 "Accounting for Uncertainty in Income Taxes" (FIN
48). FIN 48 provides guidance for how uncertain tax positions should be
recognized, measured, presented and disclosed in the financial statements. FIN
48 requires the evaluation of tax positions taken or expected to be taken in the
course of preparing the Partnership's tax returns to determine whether the tax
positions are "more-likely-than-not" of being sustained by the applicable tax
authority. Tax positions not deemed to meet the more-likely-than-not threshold
would be recorded as a tax benefit or expense in the current year. Adoption of
FIN 48 was deferred to fiscal years beginning after December 15, 2007 and is to
be applied to all open tax years as of the effective date. At this time, the
Partnership is evaluating the implications of FIN 48 and its impact on the
financial statements has not yet been determined.
In September 2006, the FASB issued Statement on Financial Accounting Standards
No. 157, "Fair Value Measurements" ("FAS 157"). This standard clarifies the
definition of fair value for financial reporting, establishes a framework for
measuring fair value and requires additional disclosures about the use of fair
value measurements. FAS 157 is effective for financial statements issued for
fiscal years beginning after November 15, 2007 and interim periods within those
fiscal years. The Partnership does not believe that adoption of FAS 157 will
impact the amounts reported in the financial statements. However, once adopted,
additional disclosures will be required about the inputs used to develop the
measurements of fair value and the effect of these fair value measurements on
earnings reported in the statement of operations.
8
Pershing Square IV, L.P.
Notes to Financial Statements (continued)
3. GUARANTEES
The Partnership enters into contracts that contain a variety of
indemnifications. The Partnership's maximum exposure under these arrangements is
unknown. However, the Partnership has not had prior claims or losses pursuant to
these contracts and expects the risk of loss to be remote.
4. RELATED PARTY TRANSACTIONS
The Partnership is not charged a management fee nor performance allocation at
the Partnership level. Management fees and performance allocation are charged
indirectly through the Partnership's investment in the Subsidiary Partnership.
During the period from June 1, 2007 (commencement of operations) to December 31,
2007, Pershing Square, L.P. ("PSLP"), an affiliated investment fund managed by
PSCM, had an investment in the Partnership. PSLP was not charged a management
fee nor performance allocation by PSCM in relation to its investment in the
Partnership and indirectly through its investment in the Subsidiary Partnership.
At December 31, 2007, PSLP owned 2.20% of the total partners' capital of the
Partnership.
5. ALLOCATION OF NET INCOME/(LOSS)
In accordance with the Partnership Agreement (the "Agreement"), net income or
loss is allocated as of the last business day of each Fiscal period, as defined,
to all partners in proportion to each partner's capital account at the time of
such allocation.
6. PARTNER'S CAPITAL
In accordance with the Agreement, a Limited Partner commits capital until
December 31, 2009 (the "Lock-Up Date"). The General Partner, in its sole
discretion, may advance or extend the Lock-Up Date for up to one year beyond
December 31, 2009 if the General Partner believes it is in the best interest of
the Partnership to do so and has also extended the Lock-Up Date for up to one
year beyond December 31, 2009 of the Subsidiary Partnership and the Fund.
9
Pershing Square IV, L.P.
Notes to Financial Statements (continued)
7. FINANCIAL HIGHLIGHTS
The following represents the ratios to average limited partners' capital and
total return information for the financial highlights for the period from June
1, 2007 (commencement of operations) to December 31, 2007:
Ratios to average limited partners' capital:
Expenses 0.24%
===============
Net investment income 0.83%
===============
Total return (42.77)%
===============
The above ratios and total return are calculated for all limited partners taken
as a whole and have not been annualized. Individual partner's ratios or returns
may vary from the above based on different management fee and performance
allocation arrangements.
10
CONSOLIDATED FINANCIAL STATEMENTS
Pershing Square IV A, L.P.
Period from June 1, 2007 (commencement of operations) to December 31, 2007 with
Report of Independent Registered Public Accounting Firm
Pershing Square IV A, L.P.
Consolidated Financial Statements
Period from June 1, 2007 (commencement of operations) to December 31, 2007
CONTENTS
Audited Consolidated Financial Statement Schedules Index
Report of Independent Registered Public Accounting Firm ................. 1
Consolidated Statement of Assets, Liabilities and Partners' Capital ..... 2
Consolidated Condensed Schedule of Investments .......................... 3
Consolidated Statement of Operations..................................... 4
Consolidated Statement of Changes in Partners' Capital .................. 5
Consolidated Statement of Cash Flows .................................... 6
Notes to Consolidated Financial Statements .............................. 7
Report of Independent Registered Public Accounting Firm
The General Partner
Pershing Square IV A, L.P.
We have audited the accompanying consolidated statement of assets, liabilities
and partners' capital of Pershing Square IV A, L.P. (the "Subsidiary
Partnership"), including the consolidated condensed schedule of investments, as
of December 31, 2007, and the related consolidated statements of operations,
changes in partners' capital and cash flows for the period from June 1, 2007
(commencement of operations) to December 31, 2007. These financial statements
are the responsibility of the Subsidiary Partnership's management. Our
responsibility is to express an opinion on these financial statements based on
our audit.
We conducted our audit in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the consolidated
financial statements are free of material misstatement. We were not engaged to
perform an audit of the Subsidiary Partnership's internal control over financial
reporting. Our audit included consideration of internal control over financial
reporting as a basis for designing audit procedures that are appropriate in the
circumstances, but not for the purpose of expressing an opinion on the
effectiveness of the Subsidiary Partnership's internal control over financial
reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the consolidated financial statements, assessing the accounting principles used
and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Pershing Square IV
A, L.P. at December 31, 2007, and the results of its operations, the changes in
its partners' capital and its cash flows for the period from June 1, 2007
(commencement of operations) to December 31, 2007, in conformity with accounting
principles generally accepted in the United States of America.
/s/ ERNST & YOUNG
March 19, 2008
1
Pershing Square IV A, L.P.
Statement of Consolidated Assets, Liabilities and Partners' Capital
(Stated in United States Dollars)
December 31, 2007
ASSETS
Cash and cash equivalents $ 68,705,098
Due from brokers 109,158,091
Investments in securities, at fair value (cost 1,059,342,171
$1,781,725,333)
Interest receivable 630,477
--------------
Total assets $1,237,835,837
==============
LIABILITIES AND PARTNERS' CAPITAL
Collateral received $ 108,826,141
Net unrealized loss on swap contracts 518,087
Accrued expenses and other liabilities 243,680
--------------
Total liabilities 109,587,908
Partners' capital 1,128,247,929
--------------
Total liabilities and partners' capital $1,237,835,837
==============
The accompanying notes are an integral part of the consolidated financial
statements.
2
Pershing Square IV A, L.P.
Consolidated Condensed Schedule of Investments
(Stated in United States Dollars)
December 31, 2007
PERCENTAGE
OF
SHARES / PARTNERS'
CONTRACTS DESCRIPTION/NAME FAIR VALUE CAPITAL
--------------------------------------------------------------------------------
INVESTMENTS IN SECURITIES
EQUITY SECURITIES
United States:
Retail
5,884,200 Target Corp. $ 294,210,000 26.08%
------------------------
Total Equity Securities (cost 294,210,000 26.08
$347,082,231)
EQUITY OPTION CONTRACTS
United States:
Retail
Target Corp., Calls, Strike
Prices $41.62 - $53.12,
75,717,131 10/02/08 - 01/15/10 765,132,171 67.82
------------------------
TOTAL EQUITY OPTION CONTRACTS (cost
$1,434,643,102) 765,132,171 67.82
------------------------
TOTAL INVESTMENTS IN SECURITIES (cost $1,059,342,171 93.90%
$1,781,725,333) ========================
DERIVATIVE CONTRACTS
TOTAL RETURN SWAPS
United States:
Banking $ (518,087) (0.05)%
------------------------
TOTAL DERIVATIVE CONTRACTS $ (518,087) (0.05)%
========================
The accompanying notes are an integral part of the consolidated financial
statements.
3
Pershing Square IV A, L.P.
Consolidated Statement of Operations
(Stated in United States Dollars)
Period from June 1, 2007 (commencement of operations) to December 31, 2007
NET REALIZED AND UNREALIZED LOSS FROM
INVESTMENTS
Net realized loss from investments in $ (40,811,094)
securities
Net change in unrealized loss from
investments in securities (722,383,162)
Net realized loss on derivative contracts (93,984,727)
Net change in unrealized loss on derivative (518,087)
contracts
-------------
Net loss from investments $(857,697,070)
INVESTMENT INCOME
Interest 18,566,663
Dividends 383,600
-------------
Total investment income 18,950,263
PARTNERSHIP EXPENSES
Management fee 2,651,777
Professional fees 1,173,267
Other 280,051
Interest 169
-------------
Total expenses 4,105,264
-------------
Net investment income 14,844,999
-------------
Net loss $(842,852,071)
=============
The accompanying notes are an integral part of the consolidated financial
statements.
4
Pershing Square IV A, L.P.
Consolidated Statement of Changes in Partners' Capital
(Stated in United States Dollars)
Period from June 1, 2007 (commencement of operations) to December 31, 2007
LIMITED GENERAL
TOTAL PARTNERS PARTNER
----------------------------------------------
Capital contributions $1,971,100,000 $1,970,100,000 $1,000,000
Net Loss (842,852,071) (842,425,326) (426,745)
----------------------------------------------
Partners' capital at end of $1,128,247,929 $1,127,674,674 $ 573,255
period ==============================================
The accompanying notes are an integral part of the consolidated financial
statements.
5
Pershing Square IV A, L.P.
Consolidated Statement of Cash Flows
(Stated in United States Dollars)
Period from June 1, 2007 (commencement of operations) to December 31, 2007
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $ (842,852,071)
Adjustments to reconcile net loss to net cash used in
operating activities:
Net realized loss from investments in securities 40,811,094
Net change in unrealized loss from investments in 722,383,162
securities
Net change in unrealized loss on swap contracts 518,087
Purchases of investments (2,834,455,274)
Proceeds from investments sold 1,011,918,847
Increase in due from brokers (109,158,091)
Increase in interest receivable (630,477)
Increase in collateral received 108,826,141
Increase in accrued expenses and other liabilities 243,680
---------------
Net cash used in operating activities (1,902,394,902)
CASH FLOWS FROM FINANCING ACTIVITIES
Capital contributions 1,971,100,000
---------------
Net change in cash and cash equivalents 68,705,098
Cash and cash equivalents at beginning of period --
---------------
Cash and cash equivalents at end of period $ 68,705,098
===============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid during the period for interest $ 169
===============
The accompanying notes are an integral part of the consolidated financial
statements.
6
10
Pershing Square IV A, L.P.
Notes to Consolidated Financial Statements
December 31, 2007
1. ORGANIZATION
Pershing Square IV A, L.P. (the "Subsidiary Partnership") is an exempted limited
partnership formed under the limited liability partnership laws of the Cayman
Islands on May 31, 2007 and commenced operations on June 1, 2007. The investment
objective the Subsidiary Partnership is to create significant capital
appreciation by investing in stock, total return swaps and call options of
Target Corporation.
The Subsidiary Partnership acts as the master fund in a "master-feeder"
structure whereby Pershing Square IV, L.P. invests all of its capital in the
Subsidiary Partnership. Pershing Square IV, L.P. (the "Partnership") is
organized as a limited partnership under the laws of the state of Delaware on
May 22, 2007 and commenced operations on June 1, 2007. The Partnership is also a
"master" fund in a "master-feeder" structure whereby Pershing Square
International IV, Ltd. invests all of its assets in the Partnership. Pershing
Square International IV, Ltd. (the "Fund") is an exempted company formed under
the limited liability laws of the Cayman Islands on May 15, 2007 and is
registered under the Cayman Islands Mutual Funds Law.
Pershing Square IV B, L.P. (the "PSIV B") is a wholly owned subsidiary of the
Subsidiary Partnership and was incorporated on July 17, 2007 under the laws of
the state of Delaware. At December 31, 2007, PSIV B did not hold any assets on
behalf of the Subsidiary Partnership.
Pershing Square Holdings GP, LLC, a limited liability company organized under
the laws of the state of Delaware and registered as a foreign company under the
laws of the Cayman Islands, will serve as the "General Partner" to the
Subsidiary Partnership and the Partnership (collectively, the "PSIV
Partnerships"). The General Partner is responsible for making all investment
decisions on behalf of the PSIV Partnerships and is solely responsible for the
development and implementation of the PSIV Partnerships' investment policy and
strategy. William A. Ackman is the managing member of the General Partner and is
primarily responsible for managing the PSIV Partnerships.
The General Partner delegates administrative functions relating to the
management of the PSIV Partnerships to Pershing Square Capital Management, L.P.
("PSCM"), a limited partnership organized under the laws of the state of
Delaware. William A. Ackman is the managing member of the general partner of
PSCM.
Pursuant to an Administration Agreement entered into in May 2007, Goldman Sachs
(Cayman) Trust, Limited (the "Administrator") has been appointed administrator
to the PSIV Partnerships. The Administrator is compensated for its services in
accordance with the fees stated in this Administration Agreement.
7
Pershing Square IV A, L.P.
Notes to Consolidated Financial Statements (continued)
2. SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The Subsidiary Partnership's consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States of America and are stated in United States dollars. The following
is a summary of the significant accounting and reporting policies used in
preparing the consolidated financial statements.
BASIS OF CONSOLIDATION
The consolidated financial statements include the results of the Subsidiary
Partnership and its subsidiary, PSIV B. Intercompany transactions have been
eliminated on consolidation.
INVESTMENT TRANSACTIONS AND RELATED INVESTMENT INCOME
The Subsidiary Partnership records its securities transactions and the related
revenue and expenses on a trade date basis. Dividends are recorded on the
ex-dividend date, net of any applicable foreign withholding taxes. Interest is
recorded on the accrual basis.
VALUATION OF INVESTMENTS
In general, the Subsidiary Partnership values investments at their last sales
price on the date of determination. If no sales occurred on such date, such
investments are valued at the mean of the last "bid" and "ask" price on the last
business day such investments were traded. Investments for which no such market
prices are available are valued at fair value by the General Partner based upon
counterparty and independent third party prices. At December 31, 2007, such
investments consisted of over-the-counter ("OTC") options with a value of
$765,132,171, and total return swap contracts with a value of ($518,087). All
unrealized gains and losses are reflected on the consolidated statement of
operations.
CASH AND CASH EQUIVALENTS
The Subsidiary Partnership considers all highly liquid financial instruments
with a maturity of three months or less to be cash equivalents. As of December
31, 2007, all cash and cash equivalents are held with an affiliate of the
Administrator.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The fair value of the Subsidiary Partnership's assets and liabilities which
qualify as financial instruments under Statement of Financial Accounting
Standards No. 107, "Disclosures About Fair Value of Financial Instruments,"
approximates the carrying amounts presented in the consolidated statement of
assets, liabilities and partners' capital.
8
Pershing Square IV A, L.P.
Notes to Consolidated Financial Statements (continued)
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
USE OF ESTIMATES
The preparation of consolidated financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the amounts
reported in the consolidated financial statements and accompanying notes. Actual
results could differ from those estimates.
INCOME TAXES
The Subsidiary Partnership is not subject to any income or capital gains taxes
in the Cayman Islands since the partners are individually liable for the taxes
on their share of the Subsidiary Partnership's income or loss. The only taxes
payable by the Subsidiary Partnership on its income are withholding taxes
applicable to dividend income. As a result, no income tax liability or expense
has been recorded in the accompanying consolidated financial statements.
NEW ACCOUNTING PRONOUNCEMENTS
On July 13, 2006, the Financial Accounting Standards Board ("FASB") released
FASB Interpretation No. 48 "Accounting for Uncertainty in Income Taxes" (FIN
48). FIN 48 provides guidance for how uncertain tax positions should be
recognized, measured, presented and disclosed in the consolidated financial
statements. FIN 48 requires the evaluation of tax positions taken or expected to
be taken in the course of preparing the Subsidiary Partnership's tax returns to
determine whether the tax positions are "more-likely-than-not" of being
sustained by the applicable tax authority. Tax positions not deemed to meet the
more-likely-than-not threshold would be recorded as a tax benefit or expense in
the current year. Adoption of FIN 48 was deferred to fiscal years beginning
after December 15, 2007 and is to be applied to all open tax years as of the
effective date. At this time, the Subsidiary Partnership is evaluating the
implications of FIN 48 and its impact on the consolidated financial statements
has not yet been determined.
In September 2006, the FASB issued Statement on Financial Accounting Standards
No. 157, "Fair Value Measurements" ("FAS 157"). This standard clarifies the
definition of fair value for financial reporting, establishes a framework for
measuring fair value and requires additional disclosures about the use of fair
value measurements. FAS 157 is effective for financial statements issued for
fiscal years beginning after November 15, 2007 and interim periods within those
fiscal years. The Subsidiary Partnership does not believe that adoption of FAS
157 will impact the amounts reported in the consolidated financial statements.
However, once adopted, additional disclosures will be required about the inputs
used to develop the measurements of fair value and the effect of these fair
value measurements on earnings reported in the consolidated statement of
operations.
9
Pershing Square IV A, L.P.
Notes to Consolidated Financial Statements (continued)
3. DUE FROM BROKERS
Due from brokers include cash balances held at the Subsidiary Partnership's
clearing broker and cash collateral received.
4. DERIVATIVE CONTRACTS AND FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
OR CONCENTRATIONS OF CREDIT RISK
In the normal course of business, the Subsidiary Partnership enters into
derivative contracts for investment purposes. Typically, derivative contracts
serve as components of the Subsidiary Partnership's investment strategies and
are utilized primarily to structure the portfolio to economically match the
investment objectives of the Subsidiary Partnership. These instruments are
subject to various risks similar to non-derivative instruments, including
market, credit, liquidity, and operational risks. The Subsidiary Partnership
manages these risks on an aggregate basis along with the risks associated with
its investing activities as part of its overall risk management policies.
The Subsidiary Partnership's derivative trading activities are primarily the
purchase and sale of OTC options, credit default swaps and total return swaps.
All derivatives are reported at fair value (as described in Note 2) in the
consolidated statement of assets, liabilities and partners' capital and changes
in fair value are reflected in the consolidated statement of operations.
Total return swaps represent agreements between two parties to make payments
based upon the performance of certain underlying assets. The Subsidiary
Partnership is obligated to pay, or entitled to receive as the case may be, the
net difference in the value determined at the onset of the swap versus the value
determined at the termination or reset date of the swap. Therefore, the amounts
required for the future satisfaction of the swaps may be greater or less than
the amounts recorded on the consolidated statement of assets, liabilities and
partners' capital. The ultimate gain or loss depends upon the prices at which
the underlying financial instruments of the swaps are valued on the settlement
date. At December 31, 2007, the Subsidiary Partnership holds total return swaps
with affiliated entities (see Note 5).
The Subsidiary Partnership clears all of its securities transactions through
major U.S.-registered broker dealers pursuant to customer agreements. At
December 31, 2007, substantially all investments, derivative contracts and
amounts due from broker are positions with and amounts due from these brokers.
The Subsidiary Partnership had substantially all its counterparty concentration
with these brokers.
10
Pershing Square IV A, L.P.
Notes to Consolidated Financial Statements (continued)
4. DERIVATIVE CONTRACTS AND FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
OR CONCENTRATIONS OF CREDIT RISK (CONTINUED)
Collateral received consists of cash received from one broker to collateralize
the Subsidiary Partnership's OTC call options purchased from that broker. At
December 31, 2007, collateral received by the Subsidiary Partnership represents
103.58% of the fair value of OTC call options purchased from that broker. The
Subsidiary Partnership is restricted in its use of the collateral and may use up
to 50% of the value of the collateral received. No collateral has been sold or
repledged as of December 31, 2007.
5. RELATED PARTY TRANSACTIONS
In accordance with the Partnership Agreement (the "Agreement"), PSCM provides
management and administrative services to the Subsidiary Partnership. As
compensation for such services, PSCM receives a quarterly management fee in
advance equal to 0.0625% (0.25% on an annual basis) of the balance in the
limited partners' capital account as of the last business day of the previous
calendar quarter, taking into account contributions made on the first day of
such calendar quarter. The management fee for the period from June 1, 2007
(commencement of operations) to December 31, 2007 was $2,651,777. The General
Partner may, in its sole discretion, elect to waive the management fee with
respect to any limited partner.
As of December 31, 2007, the Subsidiary Partnership had unrealized loss on swap
contracts with affiliated entities managed by PSCM of $518,087. This amount
relates to total return swap contracts with the affiliated entities whereby the
Subsidiary Partnership has economic exposure to various credit default swaps
held by the affiliated entities. The credit default swap contracts were
purchased for the purpose of hedging the Subsidiary Partnership's credit
exposure to certain option contract counterparties. The Subsidiary Partnership
has the same terms and economic attributes as if it were the direct buyer of
these credit default swap contracts and therefore all income and loss associated
with these swap contracts are reflected in the Subsidiary Partnership's
consolidated statement of operations.
During the period from June 1, 2007 (commencement of operations) to December 31,
2007, Pershing Square, L.P. ("PSLP") and Pershing Square International Ltd.
("PSINTL"), affiliated investment funds managed by PSCM, had an investment in
the Partnership and the Fund, respectively. PSLP and PSINTL were not charged a
management fee nor a performance allocation.
11
Pershing Square IV A, L.P.
Notes to Consolidated Financial Statements (continued)
6. GUARANTEES
The Subsidiary Partnership enters into contracts that contain a variety of
indemnifications. The Subsidiary Partnership's maximum exposure under these
arrangements is unknown. However, the Subsidiary Partnership has not had prior
claims or losses pursuant to these contracts and expects the risk of loss to be
remote.
7. ALLOCATION OF NET INCOME/(LOSS)
In accordance with the Agreement, net income or loss is allocated as of the last
business day of each Fiscal Period, as defined, to all partners in proportion to
each partner's capital account at the time of such allocation.
At the end of each fiscal year or upon a limited partners' full redemption, for
each limited partner's capital account which has been allocated net income,
there shall be allocated to the capital accounts of the General Partner, 20% of
the excess of the net income allocated to such limited partner's capital account
above the loss carryforward, if any, and the management fee with respect to the
limited partner's capital account. The General Partner in its sole discretion
has reduced the performance allocation to 10% for those limited partners that
made initial contributions of at least $100 million. For the period from June 1,
2007 (commencement of operations) to December 31, 2007, there was no performance
allocation.
The General Partner may, in its sole discretion, elect to waive or reduce the
performance allocation with respect to any limited partner.
8. PARTNERS' CAPITAL
In accordance with the Agreement, a limited partner commits capital until
December 31, 2009 (the "Lock-Up Date"). The General Partner, in its sole
discretion, may advance or extend the Lock-Up Date for up to one year beyond
December 31, 2009 if the General Partner believes it is in the best interest of
the Subsidiary Partnership to do so.
12
Pershing Square IV A, L.P.
Notes to Consolidated Financial Statements (continued)
9. FINANCIAL HIGHLIGHTS
The following represents the ratios to average limited partners' capital and
total return information for the financial highlights for the period from June
1, 2007 (commencement of operations) to December 31, 2007.
Ratios to average limited partners' capital:
Expenses 0.24%
============
Net investment income 0.83%
============
Total return (42.77)%
============
The above ratios and total return are calculated for all limited partners taken
as a whole and have not been annualized. Individual partner's ratios or returns
may vary from the above based on different management fee and performance
allocation arrangements.
13
CONSOLIDATED FINANCIAL STATEMENTS - UNAUDITED
Premier Entertainment Biloxi LLC (A Development-Stage Company)
Debtor-In-Possession
Year Ended December 31, 2006, and Period From Inception on March 27, 2003
Through December 31, 2006
Premier Entertainment Biloxi LLC
--------------------------------
(A Development-Stage Company)
-----------------------------
Debtor-In-Possession
--------------------
Consolidated Statement of Financial Position - Unaudited
December 31, 2006
Assets
Current assets:
Cash $ 858,072
Accounts receivable, net of doubtful accounts of $34,775 551,708
Prepaid insurance 2,504,357
Prepaid expenses - other 887,598
Other current assets 9,100
---------------
Total current assets 4,810,835
Property and equipment, net 134,094,320
Other noncurrent assets:
Restricted cash 134,242,459
Other assets, net 862,638
---------------
Total assets $ 274,010,252
===============
2
December 31, 2006
Liabilities and member's equity
Liabilities not subject to compromise:
Current liabilities:
Accounts payable $ 366,039
Accounts payable - construction in progress (includes related party amounts of $7,192,872) 7,341,775
Accrued interest (includes related party amount of $1,495,435) 1,495,435
Other accrued liabilities (includes related party amount of $4,090,136) 7,217,936
Notes payable 8,100,000
---------------
Total current liabilities 24,521,185
Long-term debt, less current maturities 14,430,810
Liabilities subject to compromise (Note 1) 206,721,281
---------------
Total liabilities 245,673,276
Member's contributed capital 52,775,215
Deficit accumulated during development stage (24,438,239)
---------------
Total member's equity 28,336,976
---------------
Total liabilities and member's equity $ 274,010,252
===============
See accompanying notes.
3
Premier Entertainment Biloxi LLC
--------------------------------
(A Development-Stage Company)
-----------------------------
Debtor-In-Possession
--------------------
Consolidated Statements of Operations and Member's Equity - Unaudited
Period From
Inception on
Year Ended March 27, 2003
December 31, through
2006 December 31, 2006
-------------- ------------------
Preopening expenses $ 13,860,298 $ 23,255,609
Hurricane-related expenses and write-downs 1,087,695 113,154,633
Insurance recoveries (42,370,737) (160,897,837)
Depreciation and amortization 796,450 1,245,371
------------- --------------
(Income) loss from operations (26,626,294) (23,242,224)
------------- --------------
Other income (expense):
Interest expense (21,727,344) (47,744,085)
Interest income 1,879,338 4,929,513
------------- --------------
Total other income (expense) (19,848,006) (42,814,572)
------------- --------------
Income (loss) before reorganization items 6,778,288 (19,572,348)
Reorganization items, net (Note 1) (4,865,891) (4,865,891)
------------- --------------
Net income (loss) 1,912,397 (24,438,239)
Member's equity at beginning of the period 26,424,579 --
Capital contribution from AA Capital -- 52,775,215
------------- --------------
Member's equity at end of the period $ 28,336,976 $ 28,336,976
============= ==============
See accompanying notes.
4
Premier Entertainment Biloxi LLC
--------------------------------
(A Development-Stage Company)
-----------------------------
Debtor-In-Possession
--------------------
Consolidated Statements of Cash Flows - Unaudited
Period From
Inception on
Year Ended March 27, 2003
December 31, Through December 31,
2006 2006
-------------- ------------------
Operating activities
Net income (loss) $ 1,912,397 $ (24,438,239)
Depreciation and amortization 796,450 1,245,371
Amortization of deferred financing costs, discount
and repayment premium 958,434 3,606,924
Reorganization items 6,479,361 6,479,361
Property and equipment write-downs 30,994 96,200,268
Other hurricane-related write-downs -- 638,473
Insurance recoveries (42,370,737) (160,897,837)
Changes in prepaid assets (1,872,375) (3,831,217)
Changes in other operating assets and liabilities 4,364,995 11,194,928
------------ -------------
Net cash used in operating activities (29,700,481) (69,801,968)
------------ -------------
Investing activities
Purchases of property and equipment (22,849,142) (174,094,721)
Insurance recoveries received 135,247,837 160,897,837
Purchases of government securities -- (32,946,442)
Sales of government securities 8,332,711 33,451,651
Acquisition of intangibles -- (965,672)
Change in restricted cash (100,051,158) (133,730,124)
------------ -------------
Net cash provided by (used in) investing activities 20,680,248 (147,387,471)
------------ -------------
Financing activities
Refunds of (payments for) deferred financing costs 31,301 (8,179,344)
Increase in line of credit -- 1,250,000
Proceeds from long-term debt -- 202,713,590
Proceeds from short-term borrowings 8,100,000 8,100,000
Capital contribution -- 15,180,810
Change in restricted cash -- (1,017,545)
------------ -------------
Net cash provided by financing activities 8,131,301 218,047,511
------------ -------------
Net change in cash (888,932) 858,072
Cash at beginning of period 1,747,004 --
------------ -------------
Cash at end of period $ 858,072 $ 858,072
============== =============
Cash paid during the period for:
Interest, net of capitalized interest $ 16,825,099 $ 34,944,752
============== =============
Supplemental schedule of noncash investing and financing activities:
Construction costs funded through accounts
payable and liabilities subject to compromise $ 27,085,853 $ 27,085,853
============== =============
Purchase of property and equipment funded
through notes payable $ -- $ 14,120,932
============== =============
Unpaid interest reclassified to principal
related to Junior Subordinated Note $ 1,933,324 $ 4,356,293
============== =============
See accompanying notes.
5
Premier Entertainment Biloxi LLC
--------------------------------
(A Development-Stage Company)
----------------------------
Debtor-In-Possession
--------------------
Notes to Consolidated Financial Statements - Unaudited
1. Nature of Business and Summary of Significant Accounting Policies
Premier Entertainment Biloxi LLC, a Delaware limited liability company, (Premier
Entertainment or the Company) is a development stage company and was established
to own, construct and manage the operations of the Hard Rock Hotel & Casino
Biloxi (Hard Rock Biloxi). The personal liability of the member and officers of
the Company is limited to the maximum amount permitted under the laws of the
state of Delaware.
Premier Finance Biloxi Corp. (Premier Finance) was incorporated in October 2003
as a Delaware corporation and is a wholly owned subsidiary of Premier
Entertainment. Under Mississippi law, certain expenditures are exempt from sales
tax if purchased with proceeds from industrial development revenue bonds issued
by the Mississippi Finance Corporation. Premier Finance was formed to fund the
capital expenditures that qualify for the tax-exempt status.
The Company has incurred a net loss of $24.4 million for the period from
commencement of operations on March 27, 2003 through December 31, 2006.
Construction of the property was originally completed in August 2005. However,
on August 29, 2005, the Company's casino was destroyed and the casino related
facilities, low-rise building, hotel tower and parking garage sustained
significant damage as a result of Hurricane Katrina. Reconstruction of the
property began in June 2006 and the Company commenced operations on June 30,
2007. As of that date, the Company ceased to be a development-stage company.
Basis of Presentation
The Company's accounting policies and its standards of financial disclosure are
in conformity with United States generally accepted accounting policies.
Capital Structure
On January 23, 2004, GAR LLC (GAR) received 100 Class A common units
representing a 55% membership interest in the Company. AA Capital Equity Fund,
L.P., and AA Capital Biloxi Co-Investment Fund, L.P. (together AA), received 100
Class B common units and 100 Class A preferred units representing the remaining
45% membership interest in exchange for $52.8 million of members' equity through
conversion of the unpaid principal and accrued interest on a loan and security
agreement plus an incremental cash contribution of $15.2 million. On January 24,
2005, the LLC Operating Agreement was amended to establish 100 Class C common
non-voting units, a new Class of membership interest in the Company. On this
same date, sixty-six and two-thirds (66 2/3) of the Class C common units were
granted to Joseph Billhimer, the Company's President and Chief Operating
Officer.
6
Premier Entertainment Biloxi LLC
--------------------------------
(A Development-Stage Company)
----------------------------
Debtor-In-Possession
--------------------
Notes to Consolidated Financial Statements - Unaudited (continued)
1. Nature of Business and Summary of Significant Accounting Policies (continued)
Change of Control
On April 25, 2006, LUK-Ranch Entertainment, LLC, (LRE), a Delaware limited
liability company and an indirect subsidiary of Leucadia National Corporation
(Leucadia), indirectly acquired a controlling interest in the Company by making
a capital contribution to GAR. GAR used this capital contribution to acquire
one-hundred percent (100%) of the equity interest held by AA in the Company for
an aggregate cash purchase price of $89 million.
The acquisition was made upon receipt of Mississippi Gaming Commission approval
of the acquisition of control, pursuant to a Unit Purchase Agreement by and
among GAR, AA, Leucadia, and HRHC Holdings, LLC dated as of April 6, 2006.
Pursuant to the agreement, GAR acquired all of AA's equity interest in the
Company, which, when added to GAR's existing equity interest in the Company,
represented 98% of the common equity of the Company on a fully diluted basis and
100% of the voting equity of the Company (the Transaction). LRE funded GAR's
acquisition of AA's equity interest in the Company by purchasing (i) 100% of the
Class B Common Units of GAR, representing approximately 45% of the total common
units of GAR and (ii) 100% of the Class A Preferred Units of GAR (approximately
$75.7 million at April 25, 2006), representing 100% of the preferred units in
GAR for aggregate cash consideration of $89 million. Under the terms of the GAR
operating agreement, LRE controls the Board of Managers of GAR and, as a result,
under the Company's operating agreement, LRE controls the board of managers of
the Company.
In June 2006, GAR increased its ownership to 100% of the common equity of the
Company by purchasing 100% of the Class C Common Units from Joseph Billhimer at
fair value.
As a result of the consummation of the Transaction, on May 5, 2006, BHR
Holdings, Inc. (BHR), a wholly owned indirect subsidiary of Leucadia and the
parent company of LRE, commenced a tender offer (the Offer) for all of the
outstanding $160 million principal amount of the Company's 10 3/4% First
Mortgage Notes due February 1, 2012 (the Notes) at a price equal to 101% of the
par value of the Notes, plus accrued and unpaid interest to the date of payment.
The Offer, which expired at noon on June 9, 2006, satisfied the Company's
obligation under the Indenture to make such an offer upon the occurrence of a
change of control as defined in the Indenture. In connection with the Offer, GAR
agreed to cause Premier to pay BHR a fee of $2.0 million, which will be paid
only to the extent distributions from the Company are available for such
purpose. A liability has been recorded for this fee and is included in other
accrued liabilities on the December 31, 2006 consolidated statement of financial
position.
7
Premier Entertainment Biloxi LLC
--------------------------------
(A Development-Stage Company)
----------------------------
Debtor-In-Possession
--------------------
Notes to Consolidated Financial Statements - Unaudited (continued)
1. Nature of Business and Summary of Significant Accounting Policies (continued)
In addition, the members of the Board of Managers of Premier are entitled to be
paid an annual management fee in an aggregate amount of $2.0 million which will
be paid by Premier to the extent distributions from the Company are available
for such purpose. The Company began accruing for this fee as of the date of the
Transaction and accrued $1.4 million for this management fee in other accrued
liabilities on the December 31, 2006 consolidated statement of financial
position.
Bankruptcy Filing
On September 19, 2006 (the Petition Date), the Company filed voluntary petitions
for reorganization under chapter 11 of title 11 of the United States Code,
before the United States Bankruptcy Court (the Court) for the Southern District
of Mississippi, Southern Division (Case No. 06-50975 (ERG)). The Company sought
the Court's assistance in gaining access to Hurricane Katrina - related
insurance proceeds over which U.S. Bank National Association, in its capacity as
trustee and disbursement agent (trustee and disbursement agent) for the Notes
and a group of majority holders of the Notes had denied access. Under Chapter
11, certain claims against the Company in existence prior to the filing of the
petitions were stayed while the Company continued business operations as a
debtor-in-possession.
As a debtor-in-possession, the Company followed the guidance of Statement of
Position 90-7, Financial Reporting by Entities in Reorganization Under the
Bankruptcy Code. Accordingly, certain of the stayed claims which were impaired
under the plan are reflected in the December 31, 2006 consolidated statement of
financial position as "liabilities subject to compromise." Certain revenues and
expenses resulting from the reorganization are reported as reorganization items
in the December 31, 2006 statement of operations and member's equity.
On December 11, 2006, the Company filed with the Court a plan of reorganization
(the Plan) and subsequently filed an amended Plan with the Court on February 22,
2007.
8
Premier Entertainment Biloxi LLC
--------------------------------
(A Development-Stage Company)
----------------------------
Debtor-In-Possession
--------------------
Notes to Consolidated Financial Statements - Unaudited (continued)
1. Nature of Business and Summary of Significant Accounting Policies (continued)
On July 30, 2007, the Court entered an order confirming the Plan, subject to a
modification which the Company filed on August 1, 2007. On August 10, 2007,
Premier Entertainment and Premier Finance emerged from bankruptcy when the Plan
was substantially consummated (the Effective Date). As such, Premier
Entertainment and Premier Finance are no longer classified as
debtors-in-possession. The Court continues to retain jurisdiction of certain
matters including the ultimate resolution of the disputed escrow amount as
described below and resolution of certain other disputed claims.
Under the Plan, as approved by the Court, Noteholders received principal of $160
million and accrued unpaid interest of $9.1 million in cash on the Effective
Date. In addition, the Company placed $14.7 million in escrow with U.S. Bank.
$13.7 million of this amount represents a prepayment premium or penalty, which
the Noteholders may be entitled. The Company disputes that any prepayment
premium or penalty is due the Noteholders and as such the disputed amount has
been placed in escrow pending resolution by the Court. In addition, the Company
placed $1 million in escrow for fees and expenses which may be incurred by the
trustee in conjunction with the dispute resolution.
On the Effective Date, Peoples Bank, holder of the senior secured reducing line
of credit facility received $1.3 million of principal plus interest at a reduced
rate of 7% from the Petition Date through the Effective Date.
Holders of other secured claims received 100% of their allowed claim, including
contractual interest on the Effective Date.
Holders of general unsecured claims received 50% of their allowed claim plus
post petition interest at the federal judgment rate of 5.02% on the Effective
Date and received the balance, with interest, on October 10, 2007.
The Plan was funded by a $180 million senior secured credit facility dated
August 10, 2007 provided by BHR, an affiliate of the Company and a $20 million
loan and security agreement dated August 10, 2007 provided by International Game
Technology (IGT).
9
Premier Entertainment Biloxi LLC
--------------------------------
(A Development-Stage Company)
----------------------------
Debtor-In-Possession
--------------------
Notes to Consolidated Financial Statements - Unaudited (continued)
1. Nature of Business and Summary of Significant Accounting Policies (continued)
The BHR credit facility will mature February 2012, bears interest at 10 3/4%, is
prepayable at any time without penalty, and contains other covenants, terms and
conditions similar to those contained in the indenture that governed the Notes
(see Note 5). On the Effective Date, $160 million was advanced to the Company
under this facility. As of October 11, 2007, the full $180 million had been
advanced.
The IGT loan was funded on the Effective Date and is secured by certain IGT slot
machines, slot system, and non-IGT ancillary equipment and is payable in
thirty-five consecutive monthly installments based on a sixty-month amortization
with a balloon payment on the thirty-sixth month of the outstanding remaining
principal balance. Interest accrues at the "high Wall Street Journal prime
lending rate," currently 7.5% and the first payment of principal and interest
was due September 20, 2007. The loan also included a 2% loan fee of $139,332 for
the portion of the loan representing the non-IGT ancillary equipment.
On August 2, 2007, certain of the Noteholders filed a notice of appeal of the
confirmation order and a motion for stay of the confirmation order pending
resolution of the appeal. On August 10, 2007, the motion for stay of the
confirmation was denied by both the Court and the United States District Court
for the Southern District of Mississippi.
The Company has filed a motion to dismiss the appeal on the basis of equitable
mootness due to the fact that the Plan has been substantially carried out. A
hearing date on the appeal has not been set although the Company believes the
appeal is without merit, and intends to vigorously contest the appeal.
Liabilities Subject to Compromise
The following table summarizes the components of liabilities subject to
compromise included on the consolidated statement of financial position as of
December 31, 2006:
Senior note in default including accrued interest $ 167,166,667
F&E financing in default including accrued interest 15,559,469
Accounts payable and other accrued liabilities (a) 23,995,145
-------------
Total liabilities subject to compromise $ 206,721,281
=============
10
Premier Entertainment Biloxi LLC
--------------------------------
(A Development-Stage Company)
----------------------------
Debtor-In-Possession
--------------------
Notes to Consolidated Financial Statements - Unaudited (continued)
1. Nature of Business and Summary of Significant Accounting Policies (continued)
(a) Accounts payable and other accrued liabilities include $14.2 million
payable to affiliated parties (see Note 6).
Liabilities subject to compromise refers to pre-petition obligations that may
have been impacted by the Chapter 11 reorganization process. The amounts
represented the Company's estimate at December 31, 2006 of known or potential
obligations to be resolved in connection with the Chapter 11 proceedings.
In 2007 the resolution of liabilities recorded as of December 31, 2006 and
claims filed has resulted in a $1.3 million net reduction in those liabilities.
Such amount has been recognized as a gain in 2007.
Reorganization Items, Net
The following table summarizes the components included in reorganization items,
net on the consolidated statement of operations and member's equity for the year
ended December 31, 2006:
Professional fees $ (362,956)
Write-off of deferred financing costs and original issue discount (6,479,361)
Interest income 1,976,426
---------------
Total reorganization items, net $ (4,865,891)
===============
Insurance Recoveries
On August 15, 2005, the Company purchased a comprehensive blanket insurance
policy providing up to $181.1 million in coverage for damage to real and
personal property, including business interruption coverage. The insurance was
comprised of a $25.0 million primary layer underwritten by Industrial Risk
Insurers, a $25.0 million first excess layer underwritten by several insurance
carriers, and a second excess layer comprising $131.1 million underwritten by
several insurance carriers. The syndicated coverage was spread over twelve
different insurance carriers. The Company had a 3.0% deductible on its coverage,
but purchased three additional insurance policies to reduce the Company's
exposure related to that deductible.
11
Premier Entertainment Biloxi LLC
--------------------------------
(A Development-Stage Company)
----------------------------
Debtor-In-Possession
--------------------
Notes to Consolidated Financial Statements - Unaudited (continued)
1. Nature of Business and Summary of Significant Accounting Policies (continued)
As of December 31, 2006 the Company had reached final settlements with all but
one of its carriers under its blanket insurance policies and had collected a
total of $160.9 million. Only $12.6 million of $14.0 million face value of
insurance policies remained unsettled at December 31, 2006. In January 2008, the
Company settled the remaining insurance claim and by February 21, 2008 the
Company had collected an additional $11.4 million.
The Company recognized insurance recoveries of $42.4 million in 2006 and a total
of $160.9 million from the period of inception through December 31, 2006.
Principles of Consolidation
The consolidated financial statements include the accounts of Premier
Entertainment and its wholly owned subsidiary, Premier Finance Biloxi Corp. All
significant inter-company accounts and transactions have been eliminated.
Use of Estimates
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the amounts reported in the consolidated financial
statements and accompanying notes.
Property and Equipment
Property and equipment are stated at cost. The Company capitalizes the cost of
purchases of property and equipment and capitalizes the cost of improvements to
property and equipment that increase the value or extend the useful life of the
asset. Maintenance and repairs are charged to expense as incurred. Depreciation
is computed using the straight-line method over the following estimated useful
lives of the assets:
Building 40 years
Furniture, fixtures, and equipment 5-10 years
12
Premier Entertainment Biloxi LLC
--------------------------------
(A Development-Stage Company)
----------------------------
Debtor-In-Possession
--------------------
Notes to Consolidated Financial Statements - Unaudited (continued)
1. Nature of Business and Summary of Significant Accounting Policies (continued)
The Company has included in the consolidated statements of operations and
members' equity depreciation expense related to office space and equipment that
was placed in service after Hurricane Katrina.
In accordance with SFAS No. 34, Capitalization of Interest Cost (SFAS No. 34),
the Company capitalizes the interest cost associated with major development and
construction projects as part of the cost of the project. Interest is typically
capitalized on amounts expended on the project using the weighted-average cost
of outstanding borrowings. Capitalization of interest starts when construction
activities, as defined in SFAS No. 34, begin and ceases when construction is
substantially complete or development activity is suspended for more than a
brief period. Accordingly, the Company suspended the capitalization of interest
after Hurricane Katrina and resumed capitalization of interest in third quarter
2006 when construction of the facility recommenced.
Long-Lived Assets
Long-lived assets to be held and used by the Company are reviewed to determine
whether any events or changes in circumstances indicate the carrying amount of
the asset may not be recoverable. Factors that might indicate a potential
impairment may include, but are not limited to, significant decreases in the
market value of the long-lived asset, a significant change in the long-lived
asset's physical condition, a change in industry conditions or a reduction in
cash flows associated with the use of the long-lived asset. If these or other
factors indicate the carrying amount of the asset may not be recoverable, the
Company determines whether an impairment has occurred through the use of an
undiscounted cash flow analysis of the asset at the lowest level for which
identifiable cash flows exist. If an impairment has occurred, the Company
recognizes a loss for the difference between the carrying amount and the fair
value of the asset. The fair value of the asset is measured using market prices
or, in the absence of market prices, is based on an estimate of discounted cash
flows. The Company has included an impairment charge in its consolidated
statements of operations and members' equity of $1.1 million and $113.2 million
for the year ended December 31, 2006 and the period from inception through
December 31, 2006, respectively, as a result of the damage caused by Hurricane
Katrina.
13
Premier Entertainment Biloxi LLC
--------------------------------
(A Development-Stage Company)
----------------------------
Debtor-In-Possession
--------------------
Notes to Consolidated Financial Statements - Unaudited (continued)
1. Nature of Business and Summary of Significant Accounting Policies (continued)
Intangible Assets
The Company has a license agreement with Hard Rock Hotel Licensing, Inc., which
provides for an initial term of twenty years and the option to renew for two
successive ten-year terms. Under the license agreement, the Company has the
exclusive right to use and develop the "Hard Rock" brand name in connection with
a hotel and casino resort in Biloxi, Mississippi. As consideration for the
licensed rights as provided in the license agreement, the Company paid a
one-time territory fee of $500,000. This cost was capitalized and is recorded as
other assets on the consolidated statement of financial position and is being
amortized over a 20-year period that began in September 2005.
Deferred Financing Costs and Debt Discount
The costs of issuing long-term debt are capitalized as other assets and, along
with the original issue discount, are amortized over the term of the related
debt. At September 19, 2006 in conjunction with the bankruptcy filing previously
described, the Company wrote off the unamortized balance of the cost of issuing
the Notes in the amount of $4.9 million and the related original issue discount
of $1.6 million. These costs were written off to accurately adjust the amount of
the Notes allowed by the Bankruptcy Court as a claim against the Company and
have been classified on the consolidated statements of operations and members'
equity as reorganization items.
Self-Insurance
Prior to July 1, 2006, the Company was self-insured for employee medical
insurance coverage up to an individual stop loss of $15,000. Self-insurance
liabilities are estimated based on the Company's claims experience and are
included in other accrued liabilities on the consolidated statement of financial
positions. Such amounts are immaterial at December 31, 2006. Effective July 1,
2006, the Company changed to a fully insured plan.
14
Premier Entertainment Biloxi LLC
--------------------------------
(A Development-Stage Company)
----------------------------
Debtor-In-Possession
--------------------
Notes to Consolidated Financial Statements - Unaudited (continued)
1. Nature of Business and Summary of Significant Accounting Policies (continued)
Preopening Costs
Preopening costs are expensed as incurred, consistent with Statement of Position
98-5, Reporting on the Costs of Start-up Activities (SOP 98-5). Expenses
incurred include payroll and payroll related expenses, marketing expenses,
rental expenses, outside services, legal and professional fees, and other
expenses related to the start-up phase of operations.
Income Taxes
As a limited liability company, the Company has elected to be treated as a
partnership for income tax purposes; accordingly, any tax related to the
Company's income is the obligation of its members and no federal or state income
tax provision has been recorded in the Company's consolidated financial
statements.
New Accounting Pronouncement
Effective January 1, 2006, the Company adopted the provision of FASB Statement
No. 123(R), Share-Based Payment, which is a revision of SFAS 123 and supersedes
APB Opinion No. 25. The effect of adopting this new standard had no effect on
the Company's accounting for its 2004 Membership Interest Appreciation Rights
Plan which allow for the receipt of an award based on the increase in value of
the Company. The plan was terminated in June 2006 and no other awards or grants
are outstanding.
2. Restricted Cash
The net proceeds from the issuance of the Notes, a portion of the equity
investment and the proceeds from the junior subordinated note were deposited
into a construction disbursement account and a tidelands lease reserve account
pursuant to the disbursement agreement of the Notes and utilized to construct
the property which was substantially completed in August 2005 and subsequently
damaged by Hurricane Katrina. The insurance proceeds related to Hurricane
Katrina totaling $160.9 million have been deposited into the restricted accounts
held by the trustee. These accounts were pledged to the trustee and disbursement
agent as security for the Company's obligations under the Notes, and could only
be released to the Company in accordance with the disbursement agreement or
approval from the Court (see Note 1).
15
Premier Entertainment Biloxi LLC
--------------------------------
(A Development-Stage Company)
----------------------------
Debtor-In-Possession
--------------------
Notes to Consolidated Financial Statements - Unaudited (continued)
2. Restricted Cash (continued)
The Company also has a $1.0 million certificate of deposit which is pledged as
security for the Company's obligations under the Hard Rock license agreement. In
the accompanying consolidated statement of financial position, restricted cash
is classified as noncurrent as it is primarily designated for the reconstruction
of property and purchases of equipment. Restricted cash includes the following:
Construction disbursement $ 117,047,468
Tidelands lease reserve 1,045,240
Insurance proceeds in escrow (a) 15,149,751
--------------
Cash restricted by the Notes 133,242,459
Certificate of deposit restricted by the Hard Rock license agreement 1,000,000
--------------
Total restricted cash $ 134,242,459
==============
(a) Includes $1.3 million escrowed on behalf of Peoples Bank and $13.8
million escrowed on behalf of IGT pending determination of their
rights, if any to the insurance proceeds.
3. Property and Equipment
Property and equipment held at December 31, 2006 consisted of the following:
Land $ 30,991,578
Building 50,707,794
Equipment 12,643,492
Construction in progress 40,848,974
--------------
135,191,838
Less accumulated depreciation 1,097,518
--------------
Property and equipment, net $ 134,094,320
==============
Depreciation expense totaled $771,450 in 2006. Interest capitalized totaled $0.5
million in 2006 and $16.9 million for the period from inception through December
31, 2006.
16
Premier Entertainment Biloxi LLC
--------------------------------
(A Development-Stage Company)
----------------------------
Debtor-In-Possession
--------------------
Notes to Consolidated Financial Statements - Unaudited (continued)
4. Other Noncurrent Assets
Other assets, net consisted of the following:
Hard Rock license fee, net of accumulated amortization of $33,334 $ 466,666
Deferred financing costs, net of accumulated amortization of $151,823 273,177
Deposit 122,795
------------
Other assets, net $ 862,638
============
Amortization expense for the Hard Rock license fee and the leasehold contract
was $25,000 in 2006. For the Hard Rock license fee, the estimated amortization
expense per year for the next five years is $25,000.
5. Long-Term Debt and Loan and Security Agreement
Long-term debt as of December 31, 2006 is as follows:
10 3/4% First Mortgage Notes due 2012 in default, net $ 160,000,000
15% Junior Subordinated Note due 2012 in default, net 14,430,810
Variable rate IGT note payable in default 12,870,932
Variable rate Senior Secured Reducing Line of Credit
Facility in default 1,250,000
Fixed rate BHR note payable in default 8,100,000
---------------
196,651,742
---------------
Less debt and loan agreements classified as liabilities
subject to compromise 174,120,932
Less notes payable current 8,100,000
---------------
Long-term debt $ 14,430,810
===============
17
Premier Entertainment Biloxi LLC
--------------------------------
(A Development-Stage Company)
----------------------------
Debtor-In-Possession
--------------------
Notes to Consolidated Financial Statements - Unaudited (continued)
5. Long-Term Debt and Loan and Security Agreement (continued)
10 3/4% First Mortgage Notes due 2012
On January 23, 2004, the Company issued $160 million of 10 3/4% First Mortgage
Notes due February 1, 2012 in a private placement offering which were
subsequently exchanged in an exchange offer registered on Form S-4. The
unamortized discount of $1.6 million, which was being amortized over the term of
the Notes was written off during the year ended December 31, 2006 as a result of
the bankruptcy filing. The Notes were senior to all existing and future senior
unsecured indebtedness, but were subordinated to $14.1 million of senior secured
indebtedness incurred to finance the acquisition and installation of furniture,
fixtures, and equipment. The Notes were secured by a pledge of the Company's
membership interests and substantially all of the existing and future assets,
except for assets securing certain other indebtedness. In addition, the trustee
and disbursement agent was named as a loss payee on behalf of the noteholders
under the Company's insurance policies.
Interest on the Notes was payable semiannually on each February 1 and August 1
through maturity. Under the governing indenture, the Notes may have been
redeemed, in whole or in part, at any time on or after February 1, 2008 at the
redemption prices (expressed as percentages of principal amount) set forth
below, plus accrued and unpaid interest, to the applicable redemption date, if
redeemed during the 12-month period beginning on February 1 of the years
indicated below:
Year Percentage
-------------------- --------------
2008 105.38%
2009 102.69%
2010 and thereafter 100.00%
In addition, up to 35% of the Notes may have been redeemed at a premium on or
prior to February 1, 2007 with the net cash proceeds of an initial public
offering. Deferred financing costs, net of accumulated amortization of $4.9
million, which were incurred in connection with the issuance were written off at
September 19, 2006 as a result of the bankruptcy filing. Prior to the write-off,
these deferred financing costs had been included in other assets and were being
amortized over the term of the related long-term debt. As a result of the
bankruptcy, the Notes are classified as liabilities subject to compromise in the
accompanying consolidated statement of financial positions. The notes were paid
in full on August 10, 2007 in accordance with the Company's confirmed plan of
reorganization (see Note 1).
18
Premier Entertainment Biloxi LLC
--------------------------------
(A Development-Stage Company)
----------------------------
Debtor-In-Possession
--------------------
Notes to Consolidated Financial Statements - Unaudited (continued)
5. Long-Term Debt and Loan and Security Agreement (continued)
15% Junior Subordinated Note due 2012
Concurrently with the issuance of the Notes, the Company borrowed $10.0 million
in the form of a junior subordinated note due August 1, 2012 from Rank America,
Inc., an affiliate of The Rank Group Plc, and owner of Hard Rock Hotel
Licensing, Inc. Interest on the junior subordinated note accrues at a rate of
15% per annum and will be paid semiannually. If the Company had opened as
planned, the first interest payment would have been due on February 1, 2006.
Accrued interest at each semi annual interest payment date prior to opening is
added to the principal balance. The Company will be required to pay a repayment
premium of 3% of the principal amount of the junior subordinated note when it is
repaid. Such premium is being accrued over the term of the junior subordinated
note. On April 25, 2006, LRE, an affiliated company, acquired the junior
subordinated note from Rank America, Inc.
IGT Note Payable
On January 5, 2005, the Company entered into a Commercial Sales and Security
Agreement (the IGT Agreement) with IGT for the financing of certain gaming
devices and systems. Pursuant to the IGT Agreement, the Company purchased
approximately 1,100 slot devices from IGT, as well as software licenses and
related equipment for the gaming system. Under the IGT Agreement, interest
accrued at the "high Wall Street Journal prime lending rate" (8.25% at December
31, 2006) and payments were based on a 60-month amortization payable in
thirty-six monthly installments of principal and accrued interest with the
balance due on the thirty-seventh month (November 2008). IGT was named as a loss
payee under the Company's insurance policies. As a result of the bankruptcy, the
amount due under the IGT Agreement is classified as liabilities subject to
compromise in the accompanying consolidated statement of financial position. In
accordance with the Company's confirmed plan of reorganization, $7.6 million of
principal, accrued pre-petition interest at the contract rate, and post-petition
accrued interest at the reduced rate of 5.02% was paid on August 10, 2007. The
remaining balance of principal and accrued interest was paid October 10, 2007
(see Note 1).
19
Premier Entertainment Biloxi LLC
--------------------------------
(A Development-Stage Company)
----------------------------
Debtor-In-Possession
--------------------
Notes to Consolidated Financial Statements - Unaudited (continued)
5. Long-Term Debt and Loan and Security Agreement (continued)
Senior Secured Reducing Line of Credit Facility
On August 26, 2005, the Company received a $1.3 million loan from The Peoples
Bank pursuant to a $10.0 million Senior Secured Reducing Line of Credit Facility
(the Credit Facility). The Credit Facility was secured by a security interest in
certain collateral purchased by the Company and the lender was named as a loss
payee under the Company's blanket insurance policies. The Credit Facility had a
term of 66 months that included an initial funding period that ended on December
31, 2005.
Interest on the Credit Facility accrued at the rate of 9.6659% at December 31,
2006, based on twelve-month LIBOR plus 4.25%. On December 31, 2005, the
outstanding balance of the Credit Facility was converted into a fully
amortizing, five-year term loan due December 31, 2010, requiring quarterly
payments of principal and interest. As a result of the bankruptcy, the amounts
due under the credit facility are classified as liabilities subject to
compromise in the accompanying consolidated statement of financial position. In
accordance with the Company's confirmed plan of reorganization, the credit
facility was paid in full, with post petition accrued interest at the reduced
rate of 7% per annum on August 10, 2007.
BHR Holdings, Inc. Note Payable
On May 23, 2006, the Company received an $8.0 million loan from BHR, an
affiliated company. An additional $0.1 million was received in September 2006.
The note bears interest at 12% per annum and the principal balance and all
accrued and unpaid interest is due on the earlier of May 23, 2007 or the date on
which sufficient insurance proceeds received from certain insurance carriers
become available to repay the note.
Other
On July 1, 2005, the Company obtained an Irrevocable Letter of Credit from The
Peoples Bank in favor of Hard Rock Hotel Licensing, Inc. in the amount of $1.0
million to comply with the terms and conditions of the Licensing Agreement with
Hard Rock Hotel Licensing, Inc. The Letter of Credit is secured by a certificate
of deposit in the amount of $1.0 million for a term of 90 days and will
automatically renew.
20
Premier Entertainment Biloxi LLC
--------------------------------
(A Development-Stage Company)
----------------------------
Debtor-In-Possession
--------------------
Notes to Consolidated Financial Statements - Unaudited (continued)
6. Related Party Transactions
Roy Anderson, III a member of GAR is the President, Chief Executive Officer and
majority stockholder of Roy Anderson Corp. (RAC), the Company's general
contractor.
Pursuant to a guaranteed maximum price construction agreement, dated December
24, 2003, (the Initial Construction Agreement), as amended, RAC had constructed
the Hard Rock Casino and Hotel facilities (the Project). Total payments for
construction of the Project for the period from the commencement of operations
on March 27, 2003 through December 31, 2006 were $89.5 million, of which $71.1
million was paid directly to RAC. Post-Katrina remedial work was performed by
RAC and payments in respect thereof through December 31, 2006 were $7.5 million;
$2.9 million was outstanding and reflected in liabilities subject to compromise
in the December 31, 2006 consolidated statement of financial position. In
accordance with the Company's confirmed plan of reorganization, this amount was
paid in full on September 30, 2007 (see Note 1). On June 16, 2006, the Initial
Contract was amended and restated (the Amended Construction Agreement) to
provide for rebuilding the casino portion of the Hard Rock Biloxi and renovating
and repairing the existing hotel tower, low-rise building, parking garage and
pool and deck area that were severely damaged by Hurricane Katrina. Pursuant to
the terms of the Amended Construction Agreement, the Company agreed to pay RAC
the cost of the work performed plus a contractor's fee, with the aggregate of
such amounts not to exceed the guaranteed maximum price of $78.3 million.
Deductive change orders were issued on October 25, 2006, May 25, 2007, and
October 10, 2007, reducing the amount of the guaranteed maximum price to $73.0
million.
At December 31, 2006, work performed by RAC under the Amended Construction
Agreement was $33.6 million, of which $26.4 million was paid to RAC and $7.2
million is outstanding and reflected in accounts payable in the December 31,
2006 consolidated statement of financial position. The Company believes that the
terms of the amendments to the Amended Construction Agreement are no less
favorable to the Company than the terms of the Initial Construction Agreement.
On June 16, 2006, the Company entered into a receivables purchase agreement with
BHR and RAC. Pursuant to the terms of the receivables purchase agreement, BHR
agreed to purchase up to $40.0 million of receivables due to RAC by the Company
under the amended construction contract if such receivables are past due for
more than ten days. At December 31, 2006, $11.3 million of the amount paid to
RAC was paid under this purchase agreement. The Company has reflected these
amounts owing to BHR as liabilities subject to compromise in the December 31,
2006 consolidated statement of financial position. In accordance with the
Company's confirmed plan of reorganization, this amount was paid in full on
October 10, 2007 (see Note 1).
In March 2006, the Company entered into an agreement with RAC to provide
additional services at the property required as a result of the damage caused by
Hurricane Katrina. The Company agreed to pay RAC the cost of the work performed
plus a contractor's fee in an amount not to exceed the guaranteed maximum price
of $1.4 million. At December 31, 2006, total amount billed and paid under this
agreement was $1.4 million.
21
Premier Entertainment Biloxi LLC
--------------------------------
(A Development-Stage Company)
----------------------------
Debtor-In-Possession
--------------------
Notes to Consolidated Financial Statements - Unaudited (continued)
7. 2004 Membership Interest Appreciation Rights Plan
On June 13, 2006, the Company entered into agreements with the employees who
were participants in the Company's Membership Interest Appreciation Rights Plan,
to terminate such plan. As a result of the plan termination, payments
aggregating $198,400 were made to plan participants and are included in
preopening expenses in the consolidated statement of operations and members'
equity for the year ended December 31, 2006.
8. Commitments
Operating Leases
The Company is committed under various operating lease agreements which were
assumed in the bankruptcy proceedings primarily related to property, submerged
tidelands and equipment. Generally, these leases include renewal provisions and
rental payments, which may be adjusted for taxes, insurance and maintenance
related to the property. Future minimum rental commitments under noncancelable
operating leases are as follows:
2007 $ 806,697
2008 1,291,660
2009 1,291,660
2010 1,289,440
2011 1,285,000
Thereafter 28,061,163
---------------
$ 34,025,620
===============
Total rent expense for these long-term lease obligations was $219,900 in 2006,
and $695,513 for the period from inception through December 31, 2006.
In October 2003, the Company entered into an agreement with the State of
Mississippi for the lease and use of approximately 5 acres of submerged
tidelands. The term of the lease is for a period of 30 years. For the initial
period commencing on October 27, 2003 until the opening date as defined in the
agreement, the Company was required to pay annual rent of $21,900. From the
opening date through the remainder of the lease term, the lease rate was to be
determined as fair value on that date. In conjunction with the opening of the
casino, the revised lease rate is $985,000 annually. This rate will be adjusted
annually based on the CPI change for the period.
In November 2003, the Company entered into an agreement with the City of Biloxi,
Mississippi to lease property and the related airspace for a period of 40 years.
For the initial three years of the lease beginning in October 2004, the Company
must pay monthly rent of $12,500. The rent will increase by the Consumer Price
Index beginning on the fifth anniversary date of execution of the lease and
continuing on each fifth anniversary date.
Under the Hard Rock licensing agreement, the Company is obligated to pay an
annual lease fee of $150,000 for memorabilia displayed at the Hard Rock Biloxi.
The annual lease fee is fixed for the first two years and then adjusts
thereafter by the greater of 3% or an adjustment based on the inflation index,
but in no event shall such adjustment exceed 5% annually.
22
Premier Entertainment Biloxi LLC
--------------------------------
(A Development-Stage Company)
----------------------------
Debtor-In-Possession
--------------------
Notes to Consolidated Financial Statements - Unaudited (continued)
Other Commitments
Under the Hard Rock licensing agreement, the Company is obligated to pay an
annual fee of $1.1 million which increases to $1.5 million over five years and
increases annually thereafter based on the consumer price index, plus fees based
on future non-gaming revenues. The Company will pay a "Continuing Fee" equal to
three percent (3%) of the Licensing Fee Revenues and a marketing fee equal to
one percent (1%) of the Licensing Fee Revenues during the term of the agreement.
In no event shall these fees be construed so as to allow licensor to share in
any revenue generated by the Company's gaming operations. In April 2006, the
Company agreed to accrue $150,000 per month in lieu of any other fees due under
the terms of the license agreement until such time that the operations commence.
At December 31, 2006, $2.5 million has been accrued and recorded in other
accrued liabilities in the accompanying consolidated statement of financial
position. Such amounts were subsequently paid in November 2007.
9. Fair Value of Financial Instruments
The following methods and assumptions were used to estimate the fair value of
each class of financial instruments for which it is practical to estimate that
value:
o Cash and cash equivalents - The carrying amounts approximate fair
value because of the short maturity of these instruments.
o Restricted cash - The carrying amounts approximate fair value because
of the short maturity of these instruments.
o Long-term debt - As a result of the bankruptcy filing, the fair value
of the Company's long-term debt as of December 31, 2006 cannot be
estimated. As a result, the fair value is presented at its carrying
value. Debt obligations with a short remaining maturity are valued at
the carrying amount.
The estimated carrying amounts and fair values of the Company's financial
instruments at December 31, 2006 are as follows:
Carrying Amount Fair Value
------------------- -------------
Financial assets:
Cash and cash equivalents $ 858,072 $ 858,072
Restricted cash 134,242,459 134,242,459
Financial liabilities:
10 3/4% First mortgage notes 160,000,000 160,000,000
15% Junior subordinated note 14,430,810 14,430,810
IGT note payable 12,870,932 12,870,932
Senior secured reducing line of credit facility 1,250,000 1,250,000
BHR note payable 8,100,000 8,100,000
23
CONSOLIDATED FINANCIAL STATEMENTS
Premier Entertainment Biloxi LLC and Subsidiary
Debtor-In-Possession
Period From January 1, 2007 Through August 9, 2007
(end of pre-emergence period)
Premier Entertainment Biloxi LLC and Subsidiary
Debtor-In-Possession
Consolidated Financial Statements
Period From January 1, 2007 Through August 9, 2007
(end of pre-emergence period)
CONTENTS
Audited Consolidated Financial Statements
Report of Independent Registered Public Accounting Firm...................1
Consolidated Statement of Financial Position..............................2
Consolidated Statement of Operations and Member's Equity..................4
Consolidated Statement of Cash Flows......................................5
Notes to Consolidated Financial Statements................................6
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Member:
In our opinion, the accompanying consolidated statement of financial position
and the related consolidated statements of operations and member's equity and of
cash flows present fairly, in all material respects, the financial position of
Premier Entertainment Biloxi LLC and Subsidiary at August 9, 2007 and the
results of their operations and their cash flows for the period from January 1,
2007 to August 9, 2007 (end of pre-emergence period), in conformity with
accounting principles generally accepted in the United States of America. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audit. We conducted our audit of these statements in accordance with
generally accepted auditing standards as established by the Auditing Standards
Board (United States) and in accordance with the auditing standards of the
Public Company Accounting Oversight Board (United States). Those standards
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
As discussed in Note 1 to the consolidated financial statements, the Company
filed petitions on September 19, 2006 with the United States Bankruptcy Court
for the Southern District of Mississippi, Southern Division, for reorganization
under the provisions of Chapter 11 of the Bankruptcy Code. The Company's Joint
Plan of Reorganization was substantially consummated on August 10, 2007 and the
Company emerged from bankruptcy. In connection with its emergence from
bankruptcy, the Company did not qualify for fresh start accounting.
/s/ PricewaterhouseCoopers
March 25, 2008
1
Premier Entertainment Biloxi LLC and Subsidiary
Debtor-In-Possession
Consolidated Statement of Financial Position
AUGUST 9, 2007 (END OF PRE-EMERGENCE PERIOD)
ASSETS
Current assets:
Cash and cash equivalents $ 17,158,856
Insurance receivable 11,089,220
Accounts receivable, net of doubtful accounts of $47,107 732,069
Inventories 1,158,523
Prepaid insurance 6,184,072
Prepaid expenses - other 1,813,143
Other current assets 30,234
-----------------
Total current assets 38,166,117
Property and equipment, net 214,058,811
Other noncurrent assets:
Restricted cash 40,662,134
Other assets, net 854,718
-----------------
Total assets $ 293,741,780
=================
2
Premier Entertainment Biloxi LLC and Subsidiary
Debtor-In-Possession
Consolidated Statement of Financial Position (continued)
AUGUST 9, 2007 (END OF PRE-EMERGENCE PERIOD)
LIABILITIES AND MEMBER'S EQUITY
Liabilities not subject to compromise:
Current liabilities:
Accounts payable $ 21,920,063
Accrued interest - related party 305,139
Amounts due to related parties 11,242,201
Accrued payroll and employee benefits 1,919,525
Gaming liabilities 1,211,896
Other accrued liabilities 5,640,958
Notes payable 9,084,267
---------------------
Total current liabilities 51,324,049
Long-term debt 16,730,358
Liabilities subject to compromise (Note 1) 208,624,318
---------------------
Total liabilities 276,678,725
Member's contributed capital 52,775,215
Accumulated deficit (35,712,160)
---------------------
Total member's equity 17,063,055
---------------------
Total liabilities and member's equity $ 293,741,780
=====================
See accompanying notes.
3
Premier Entertainment Biloxi LLC and Subsidiary
Debtor-In-Possession
Consolidated Statement of Operations and Member's Equity
PERIOD FROM JANUARY 1, 2007 THROUGH AUGUST 9, 2007 (END OF PRE-EMERGENCE PERIOD)
REVENUES
Casino $ 12,317,597
Hotel 1,458,954
Food and beverage 3,070,697
Other 1,034,897
----------------------
Gross revenues 17,882,145
Less promotional allowances 2,053,719
----------------------
Net revenues 15,828,426
OPERATING EXPENSES
Casino 7,314,675
Hotel 587,673
Food and beverage 1,505,075
General and administrative 1,681,892
Insurance recoveries (11,391,658)
Management fees to related party 241,231
Pre-opening expenses 11,962,866
Utilities 310,226
Depreciation and amortization 1,664,898
Other operating 2,016,767
----------------------
Total operating expenses 15,893,645
----------------------
Loss from operations (65,219)
OTHER (INCOME) EXPENSE
Interest expense, net of capitalized
interest 11,068,508
Interest income (71,632)
----------------------
Total other (income) expense 10,996,876
Loss before reorganization items (11,062,095)
----------------------
Reorganization costs, net 211,826
----------------------
Net loss (11,273,921)
Member's equity at beginning of the period 28,336,976
----------------------
Member's equity at end of the period $ 17,063,055
======================
See accompanying notes.
4
Premier Entertainment Biloxi LLC and Subsidiary
Debtor-In-Possession
Consolidated Statement of Cash Flows
PERIOD FROM JANUARY 1, 2007 THROUGH AUGUST 9, 2007 (END OF PRE-EMERGENCE PERIOD)
OPERATING ACTIVITIES
Net loss $ (11,273,921)
Depreciation and amortization 1,664,898
Amortization of deferred financing costs, discount and repayment premium 57,839
Insurance recoveries receivable (11,089,220)
Changes in operating assets and liabilities:
Accounts receivable (180,361)
Inventories (1,158,523)
Prepaid assets (4,605,260)
Other assets (59,458)
Accounts payable and accrued expenses 11,332,205
Accrued interest 4,603,386
-------------------------
Net cash used in operating activities (10,708,415)
INVESTING ACTIVITIES
Purchases of property and equipment (66,571,126)
Change in restricted cash 93,580,325
-------------------------
Net cash provided by investing activities 27,009,199
Net change in cash and cash equivalents 16,300,784
Cash and cash equivalents at beginning of period 858,072
-------------------------
Cash and cash equivalents at end of period $ 17,158,856
=========================
Cash paid during the period for:
Interest, net of capitalized interest $ 5,921,064
=========================
Supplemental schedule of noncash investing and financing activities:
Change in construction costs funded through accounts payable, amounts due to
related parties and liabilities subject to compromise $ 15,043,007
=========================
Unpaid interest reclassified to principal $ 3,218,465
=========================
Reorganization items - See Note 1
See accompanying notes.
5
Premier Entertainment Biloxi LLC and Subsidiary
Debtor-In-Possession
Notes to Consolidated Financial Statements
AUGUST 9, 2007 (END OF PRE-EMERGENCE PERIOD)
1. NATURE OF BUSINESS AND ORGANIZATION OF COMPANY
Premier Entertainment Biloxi LLC, a Delaware limited liability company formed on
October 16, 2003, (Premier Entertainment or the Company) owns and operates the
Hard Rock Hotel & Casino Biloxi (Hard Rock Biloxi). The liability of GAR LLC
(GAR), the Company's sole member, and officers of the Company is limited to the
maximum amount permitted under the laws of the state of Delaware.
Premier Finance Biloxi Corp. (Premier Finance) was incorporated in October 2003
as a Delaware corporation and is a wholly owned subsidiary of Premier
Entertainment. Under Mississippi law, certain expenditures are exempt from sales
tax if purchased with proceeds from industrial development revenue bonds issued
by the Mississippi Finance Corporation. Premier Finance was formed to fund the
capital expenditures that qualify for the tax-exempt status.
Hard Rock Biloxi is a single casino gaming facility located on an 8.5 acre site
on the Mississippi Gulf Coast and has approximately 1,375 slot machines, 50
table games, six live poker tables, five restaurants (including a Hard Rock Cafe
and Ruth's Chris Steakhouse), a full service spa, a 5,200 square foot pool area,
3,000 square feet of retail space, an eleven-story hotel with 318 rooms and
suites and a Hard Rock Live! entertainment venue with a capacity of 1,500
persons. Hard Rock Biloxi commenced operations on June 30, 2007.
Casino operations are subject to extensive regulation in the State of
Mississippi by the Mississippi Gaming Commission and Mississippi State Tax
Commission. The Company, its ownership and management are subjected to findings
of suitability reviews by the Mississippi Gaming Commission. In addition, the
laws, rules and regulations of state and local governments in Mississippi
require the Company to hold various licenses, registrations and permits and to
obtain various approvals for a variety of matters. In order to continue
operating, the Company must remain in compliance with all laws, rules and
regulations and pay gaming taxes on its gross gaming revenues. Failure to
maintain such approvals or obtain renewals when due, or failure to comply with
new laws or regulations or changes to existing laws and regulations would have
an adverse effect on the Company's business. Management believes it is currently
in compliance with all governmental rules and regulations.
6
Premier Entertainment Biloxi LLC and Subsidiary
Debtor-In-Possession
Notes to Consolidated Financial Statements (continued)
1. NATURE OF BUSINESS AND ORGANIZATION OF COMPANY (CONTINUED)
BANKRUPTCY FILING
On September 19, 2006 (the Petition Date), the Company filed voluntary petitions
for reorganization under Chapter 11 of Title 11 of the United States Code,
before the United States Bankruptcy Court (the Court) for the Southern District
of Mississippi, Southern Division (Case No. 06-50975 (ERG). The Company sought
the Court's assistance in gaining access to Hurricane Katrina - related
insurance proceeds over which U.S. Bank National Association, in its capacity as
trustee and disbursement agent (the Trustee) for the Company's 10 3/4% First
Mortgage Notes (the Notes) and a group of majority holders of the Notes had
denied access. Under Chapter 11, certain claims against the Company in existence
prior to the filing of the petitions were stayed while the Company continued
business operations as a debtor-in-possession.
As a debtor-in-possession, the Company followed the guidance of Statement of
Position 90-7, Financial Reporting by Entities in Reorganization Under the
Bankruptcy Code. Accordingly, certain of the stayed claims which were impaired
under the plan are reflected in the August 9, 2007 consolidated statement of
financial position as "liabilities subject to compromise." Certain revenues and
expenses resulting from the reorganization are reported as reorganization items
in the August 9, 2007 statement of operations and member's equity.
On December 11, 2006, the Company filed with the Court a plan of reorganization
(the Plan) and subsequently filed an amended Plan with the Court on February 22,
2007.
On July 30, 2007, the Court entered an order confirming the Plan, subject to a
modification which the Company filed on August 1, 2007. On August 10, 2007,
Premier Entertainment and Premier Finance emerged from bankruptcy when the Plan
was substantially consummated (the Effective Date). As such, Premier
Entertainment and Premier Finance are no longer classified as
debtors-in-possession. The Court continues to retain jurisdiction of certain
matters including the ultimate resolution of the disputed escrow amount as
described below and resolution of certain other disputed claims.
7
Premier Entertainment Biloxi LLC and Subsidiary
Debtor-In-Possession
Notes to Consolidated Financial Statements (continued)
1. NATURE OF BUSINESS AND ORGANIZATION OF COMPANY (CONTINUED)
Under the Plan, as approved by the Court, noteholders received principal of $160
million and accrued unpaid interest of $9.1 million in cash on the Effective
Date. In addition, the Company placed $14.7 million in escrow with U.S. Bank.
$13.7 million of this amount represents a prepayment premium or penalty, to
which the noteholders may be entitled. The Company disputes that any prepayment
premium or penalty is due the noteholders and as such the disputed amount has
been placed in escrow pending resolution by the Court. In addition, the Company
placed $1 million in escrow for fees and expenses which may be incurred by the
Trustee in conjunction with the dispute resolution. Entitlement to the escrows
is expected to be determined by the Court during 2008. The Company believes it
is probable that the Court will approve payment of Trustee legal fees and
expenses and has fully reserved for that contingency. However, the Company does
not believe it is probable or remote that the Court will find in favor of the
noteholders with respect to the additional damages escrow, and any potential
loss can not be reasonably estimated. Accordingly, the Company has not accrued a
loss for the additional damages contingency.
On the Effective Date, Peoples Bank, holder of the senior secured reducing line
of credit facility received $1.3 million of principal plus interest at a reduced
rate of 7% from the Petition Date through the Effective Date. The reduction in
interest rate resulted in a $29,672 difference in interest costs.
Holders of other secured claims received 100% of their allowed claim, including
contractual interest on the Effective Date.
Holders of general unsecured claims received 50% of their allowed claim plus
post petition interest at the federal judgment rate of 5.02% on the Effective
Date and received the balance, with interest, on October 10, 2007. The reduction
in contractual interest rates and interest paid under the plan on certain
general unsecured claims resulted in $1.2 million difference in interest costs.
The Plan was funded by a $180 million senior secured credit facility dated
August 10, 2007 provided by BHR Holdings, Inc. (BHR), a related party, and a $20
million loan and security agreement dated August 10, 2007 provided by
International Game Technology (IGT).
The BHR credit facility will mature February 2012, bears interest at 10 3/4%, is
prepayable at any time without penalty, and contains other covenants, terms and
conditions similar to those contained in the indenture that governed the Notes
8
Premier Entertainment Biloxi LLC and Subsidiary
Debtor-In-Possession
Notes to Consolidated Financial Statements (continued)
1. NATURE OF BUSINESS AND ORGANIZATION OF COMPANY (CONTINUED)
(see Note 7). On the Effective Date, $160 million was advanced to the Company
under this facility. As of October 11, 2007, the full $180 million had been
advanced.
The IGT loan was initially funded on the Effective Date and $19.8 million had
been advanced as of August 17, 2007. The IGT loan is secured by certain IGT slot
machines, slot system, and non-IGT ancillary equipment and is payable in
thirty-five consecutive monthly installments based on a sixty-month amortization
with a balloon payment on the thirty-sixth month of the outstanding remaining
principal balance. Interest accrues at the "high Wall Street Journal prime
lending rate," (8.25% at August 9, 2007) and the first payment of principal and
interest was due September 20, 2007. The loan also includes a 2% loan fee of
$139,332 for the portion of the loan representing the non-IGT ancillary
equipment
On August 2, 2007, certain of the noteholders filed a notice of appeal of the
confirmation order and a motion for stay of the confirmation order pending
resolution of the appeal. On August 10, 2007, the motion for stay of the
confirmation was denied by both the Court and the United States District Court
for the Southern District of Mississippi.
The Company has filed a motion to dismiss the appeal on the basis of equitable
mootness due to the fact that the Plan has been substantially carried out. On
March 19, 2008 the United States District Court for the Southern District of
Mississippi granted the Company's motion to dismiss the appeal.
Liabilities Subject to Compromise
The following table summarizes the components of liabilities subject to
compromise included on the consolidated statement of financial position as of
August 9, 2007:
Senior note in default, including accrued interest $ 169,105,847
Equipment financing in default, including accrued interest 15,967,710
Accounts payable and other accrued liabilities (a) 23,550,761
-----------------------
Total liabilities subject to compromise $ 208,624,318
=======================
(a) Accounts payable and other accrued liabilities include $15.7 million
payable to related parties (see Note 8).
9
Premier Entertainment Biloxi LLC and Subsidiary
Debtor-In-Possession
Notes to Consolidated Financial Statements (continued)
1. NATURE OF BUSINESS AND ORGANIZATION OF COMPANY (CONTINUED)
Liabilities subject to compromise refers to pre-petition obligations that may
have been impacted by the Chapter 11 reorganization process. At August 9, 2007,
liabilities subject to compromise represents the balances of pre-petition
liabilities as resolved by the Plan.
REORGANIZATION ITEMS, NET
The following table summarizes the components included in reorganization items,
net on the consolidated statement of operations and member's equity for the
period from January 1, 2007 through August 9, 2007:
Professional fees $ 3,738,148
Net gain on claim settlements (1,069,981)
Interest income (2,456,341)
----------------------
Total reorganization items, net $ 211,826
======================
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION AND USE OF ESTIMATES
The Company's accounting policies and its standards of financial disclosure are
in conformity with United States generally accepted accounting principles. The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the amounts reported in the consolidated financial
statements and accompanying notes. Significant estimates include the estimated
useful lives for depreciable assets, the estimated allowance for doubtful
accounts receivable, estimated cash flows in assessing the recoverability of
long-lived assets, and estimated liabilities for the slot bonus point program
and self insurance claims. Actual results could differ significantly from those
estimates.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of Premier
Entertainment and its wholly owned subsidiary, Premier Finance Biloxi Corp. All
significant inter-company accounts and transactions have been eliminated.
10
Premier Entertainment Biloxi LLC and Subsidiary
Debtor-In-Possession
Notes to Consolidated Financial Statements (continued)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
CASH AND CASH EQUIVALENTS
Cash includes cash required for gaming operations. For purposes of reporting the
statements of cash flows, the Company considers all cash accounts and all
short-term investments with maturity dates of ninety days or less when purchased
to be cash equivalents.
ACCOUNTS RECEIVABLE AND ALLOWANCE FOR DOUBTFUL ACCOUNTS
Accounts receivable are principally comprised of casino and hotel receivables,
which do not bear interest and are recorded at cost. The Company extends credit
to approved casino customers following background checks and investigations of
creditworthiness. The Company reserves an estimated amount of receivables that
may not be collected. The methodology for estimating the allowance includes
specific reserves and applying various percentages to aged receivables.
Historical collection rates are considered, as are customer relationships, in
determining specific allowances. As with many estimates, management must make
judgments about potential actions by third parties in establishing and
evaluating the allowance for bad debts.
INVENTORIES
Inventories, consisting principally of food, beverages and operating supplies,
are stated at the lower of cost (first-in, first-out) or market.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost less accumulated depreciation and
amortization. The Company capitalizes the cost of purchases of property and
equipment and capitalizes the cost of improvements to property and equipment
that increase the value or extend the useful life of the asset. Maintenance and
repairs are charged to expense as incurred. Depreciation is computed using the
straight-line method over the following estimated useful lives of the assets:
Land improvements 20 years
Building 40 years
Furniture, fixtures, and equipment 3-10 years
11
Premier Entertainment Biloxi LLC and Subsidiary
Debtor-In-Possession
Notes to Consolidated Financial Statements (continued)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
In accordance with SFAS No. 144, "Accounting for the Impairment or Disposal of
Long-lived Assets", long-lived assets to be held and used by the Company are
reviewed to determine whether any events or changes in circumstances indicate
the carrying amount of the asset may not be recoverable. Factors that might
indicate a potential impairment may include, but are not limited to, significant
decreases in the market value of the long-lived asset, a significant change in
the long-lived asset's physical condition, a change in industry conditions or a
reduction in cash flows associated with the use of the long-lived asset. If
these or other factors indicate the carrying amount of the asset may not be
recoverable, the Company determines whether an impairment has occurred through
the use of an undiscounted cash flow analysis of the asset at the lowest level
for which identifiable cash flows exist. If an impairment has occurred, the
Company recognizes a loss for the difference between the carrying amount and the
fair value of the asset. The fair value of the asset is measured using market
prices or, in the absence of market prices, is based on an estimate of
discounted cash flows. At August 9, 2007 and for the period January 1, 2007
through August 9, 2007, there has been no impairment of long-lived assets.
CAPITALIZATION OF INTEREST
In accordance with SFAS No. 34, Capitalization of Interest Cost (SFAS No. 34),
the Company capitalizes the interest cost associated with construction projects
as part of the cost of the project. Interest is typically capitalized on amounts
expended on the project using the weighted-average cost of outstanding
borrowings. Capitalization of interest starts when construction activities, as
defined in SFAS No. 34, begin and ceases when construction is substantially
complete. Such capitalized interest becomes part of the cost of the related
asset and is depreciated over the estimated useful life.
INTANGIBLE ASSETS
The Company has a license agreement with Hard Rock Hotel Licensing, Inc., which
provides for an initial term of twenty years and the option to renew for two
successive ten-year terms. Under the license agreement, the Company has the
exclusive right to use the "Hard Rock" brand name in connection with its hotel
and casino resort. As consideration for the licensed rights as provided in the
license agreement, the Company paid a one-time territory fee of $500,000. This
cost was capitalized and is recorded as other assets on the consolidated
statement of financial position and is being amortized over a 20-year period
that began in September 2005.
12
Premier Entertainment Biloxi LLC and Subsidiary
Debtor-In-Possession
Notes to Consolidated Financial Statements (continued)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
REVENUE AND PROMOTIONAL ALLOWANCES
Casino revenue is the aggregate net difference between gaming wins and losses,
with liabilities recognized for funds deposited by customers before gaming play
occurs, for chips outstanding and "ticket-in, ticket-out" coupons in the
customers' possession, and for accruals related to the anticipated payout of
progressive jackpots. Progressive slot machines, which contain base jackpots
that increase at a progressive rate based on the number of credits played, are
charged to revenue as the amount of the progressive jackpots increase. Sales
incentives to customers such as points earned in point-loyalty programs related
to gaming play are recorded as a reduction of gross casino revenues.
Hotel revenue recognition criteria are met at the time of occupancy. Food and
beverage revenue recognition criteria are met at the time of service. Advance
deposits for hotel rooms are recorded as liabilities until revenue recognition
criteria are met.
The retail value of accommodations, food and beverage, and other services
furnished to hotel/casino guests without charge is included in gross revenue and
then deducted as promotional allowances. The estimated retail value of such
promotional allowances is included in operating revenues as follows:
Food & beverage $ 1,546,760
Rooms 243,640
Other 263,319
-----------------------
Total $ 2,053,719
=======================
The estimated departmental cost of providing such promotional allowances is
included in casino operating expenses as follows:
Food & beverage $ 1,014,003
Rooms 118,385
Other 378,759
-----------------------
Total $ 1,511,147
=======================
13
Premier Entertainment Biloxi LLC and Subsidiary
Debtor-In-Possession
Notes to Consolidated Financial Statements (continued)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
FREQUENT PLAYERS PROGRAM
The Company has established a promotional club to encourage repeat business from
frequent and active slot machine customers. Members earn points based on gaming
activity and such points can be redeemed for free slot play. The Company accrues
for club points as a reduction to gaming revenue based upon the estimates for
expected redemptions.
ADVERTISING COSTS
Costs for advertising are expensed as incurred. Advertising costs included in
casino expense was $350,956 for the period from January 1, 2007 through August
9, 2007.
SELF-INSURANCE
The Company is self-insured for employee medical insurance coverage up to an
individual stop loss of $50,000. Self-insurance liabilities are estimated based
on the Company's claims experience and are included in other accrued liabilities
on the consolidated statement of financial position. Such amount at August 9,
2007 was $345,817. At August 9, 2007, the total amount of claims exceeding the
stop loss was immaterial.
PRE-OPENING COSTS
Pre-opening costs are expensed as incurred, consistent with Statement of
Position 98-5, Reporting on the Costs of Start-up Activities (SOP 98-5).
Expenses incurred include payroll and payroll related expenses, marketing
expenses, rental expenses, outside services, legal and professional fees,
management fees to related party and other expenses related to the start-up
phase of operations.
INCOME TAXES
As a limited liability company, the Company has elected to be treated as a
partnership for income tax purposes; accordingly, any tax related to the
Company's income is the obligation of its member and no federal or state income
tax provision has been recorded in the Company's consolidated financial
statements.
14
Premier Entertainment Biloxi LLC and Subsidiary
Debtor-In-Possession
Notes to Consolidated Financial Statements (continued)
3. HURRICANE INSURANCE RECOVERIES
On August 29, 2005, just two days before the Hard Rock Biloxi was originally
scheduled to open to the public, Hurricane Katrina hit the Mississippi Gulf
Coast and severely damaged the hotel and related structures and completely
destroyed the casino.
On August 15, 2005, the Company purchased a comprehensive blanket insurance
policy providing up to $181.1 million in coverage for damage to real and
personal property, including business interruption coverage. The insurance was
comprised of a $25.0 million primary layer underwritten by Industrial Risk
Insurers, a $25.0 million first excess layer underwritten by several insurance
carriers, and a second excess layer comprising $131.1 million underwritten by
several insurance carriers. The syndicated coverage was spread over twelve
different insurance carriers. The Company had a 3.0% deductible on its coverage,
but purchased three additional insurance policies to reduce the Company's
exposure related to that deductible.
As of August 9, 2007, the Company had reached final settlements with all but one
of its carriers under its blanket insurance policies and had collected total
insurance recoveries of $161.2 million. In January 2008, the Company settled the
remaining insurance claim. As of and for the period ended August 9, 2007, the
Company has recognized insurance recoveries of $11.4 million with an insurance
receivable of $11.1 million. Such receivable was collected in full on February
21, 2008. All other insurance recoveries were recognized in years ended prior to
2007.
4. RESTRICTED CASH
Restricted cash consists of cash and highly liquid instruments with original
maturities of 90 days or less, which carrying amounts approximate fair value.
The net proceeds from the issuance of the Notes, a portion of the equity
investment and the proceeds from the junior subordinated note were deposited
into a construction disbursement account and a tidelands lease reserve account
pursuant to the disbursement agreement of the Notes. These proceeds were
utilized to construct the property which was substantially completed in August
2005 and subsequently damaged by Hurricane Katrina. The insurance proceeds
related to Hurricane Katrina received prior to August 9, 2007 totaling $161.2
million have been deposited into the restricted accounts held by the Trustee.
These accounts were pledged to the Trustee as security for the Company's
obligations under the Notes, and could only be released to the Company in
accordance with the disbursement agreement or approval from the Court (see Note
1). The Company also has a $1.0 million certificate of deposit which is pledged
as security for the Company's obligations under the Hard
15
Premier Entertainment Biloxi LLC and Subsidiary
Debtor-In-Possession
Notes to Consolidated Financial Statements (continued)
4. RESTRICTED CASH (CONTINUED)
Rock license agreement. In the accompanying consolidated statement of financial
position, restricted cash is classified as noncurrent as it is primarily
designated for the reconstruction of property and purchases of equipment.
Restricted cash at August 9, 2007 includes the following:
Construction disbursement $ 23,157,552
Tidelands lease reserve 880,872
Insurance proceeds in escrow (a) 15,623,710
-----------------------
Cash restricted by the Notes 39,662,134
Certificate of deposit restricted by the Hard
Rock license agreement 1,000,000
-----------------------
Total restricted cash $ 40,662,134
=======================
(a) Includes $1.3 million escrowed on behalf of Peoples Bank and $14.3
million escrowed on behalf of IGT pending determination of their
rights, if any to the insurance proceeds.
5. PROPERTY AND EQUIPMENT
Property and equipment held at August 9, 2007 consisted of the following:
Land $ 31,416,920
Building 131,072,698
Equipment 54,316,354
-----------------------
216,805,972
Less accumulated depreciation 2,747,161
-----------------------
Property and equipment, net $ 214,058,811
=======================
Depreciation expense totaled $1.6 million for the period from January 1, 2007
through August 9, 2007. Interest capitalized for the period from January 1, 2007
through August 9, 2007 was $2.7 million.
16
Premier Entertainment Biloxi LLC and Subsidiary
Debtor-In-Possession
Notes to Consolidated Financial Statements (continued)
6. OTHER NONCURRENT ASSETS
Other assets, net consisted of the following at August 9, 2007:
Hard Rock license fee, net of accumulated amortization of
$48,589 $ 451,411
Deferred financing costs, net of accumulated amortization of
$182,813 242,187
Deposit 161,120
-----------------------
Other assets, net $ 854,718
=======================
Amortization expense for the Hard Rock license fee and the leasehold contract
was $15,137 for the period from January 1, 2007 through August 9, 2007. For the
Hard Rock license fee, the estimated amortization expense per year for the next
five years is $25,000.
7. LONG-TERM DEBT AND LOAN AND SECURITY AGREEMENT
Long-term debt as of August 9, 2007 is as follows:
10 3/4% First Mortgage Notes due 2012 in default $ 160,000,000
15% Junior Subordinated Note due 2012 16,730,358
Variable rate IGT note payable in default 12,870,932
Variable rate Senior Secured Reducing Line of Credit
Facility in default 1,250,000
Fixed rate BHR note payable in default 9,084,267
------------------------
199,935,557
Less debt and loan agreements classified as liabilities
subject to compromise 174,120,932
Less notes payable current 9,084,267
------------------------
Long-term debt $ 16,730,358
========================
10 3/4% FIRST MORTGAGE NOTES DUE 2012
On January 23, 2004, the Company issued $160 million of 10 3/4% First Mortgage
Notes due February 1, 2012 in a private placement offering which were
subsequently exchanged in an exchange offer registered on Form S-4. The Notes
were senior to all existing and future senior unsecured indebtedness, but were
subordinated to $14.1 million of senior secured indebtedness incurred to finance
17
Premier Entertainment Biloxi LLC and Subsidiary
Debtor-In-Possession
Notes to Consolidated Financial Statements (continued)
7. LONG-TERM DEBT AND LOAN AND SECURITY AGREEMENT (CONTINUED)
the acquisition and installation of furniture, fixtures, and equipment. The
Notes were secured by a pledge of the Company's membership interests and
substantially all of the existing and future assets, except for assets securing
certain other indebtedness. In addition, the Trustee was named as a loss payee
on behalf of the noteholders under the Company's insurance policies.
Interest on the Notes was payable semiannually on each February 1 and August 1
through maturity. Under the governing indenture, the Notes may have been
redeemed, in whole or in part, at any time on or after February 1, 2008 at the
redemption prices (expressed as percentages of principal amount) set forth
below, plus accrued and unpaid interest, to the applicable redemption date, if
redeemed during the 12-month period beginning on February 1 of the years
indicated below:
-------------------------------------------------
YEAR PERCENTAGE
-------------------------------------------------
2008 105.38%
2009 102.69%
2010 and thereafter 100.00%
In addition, up to 35% of the Notes may have been redeemed at a premium on or
prior to February 1, 2007 with the net cash proceeds of an initial public
offering. As a result of the bankruptcy, the Notes are classified as liabilities
subject to compromise in the accompanying consolidated statement of financial
position. The Notes were paid in full on August 10, 2007 in accordance with the
Company's confirmed plan of reorganization (see Note 1).
15% JUNIOR SUBORDINATED NOTE DUE 2012
On January 13, 2004 the Company borrowed $10.0 million in the form of a junior
subordinated note due August 1, 2012 from Rank America, Inc., an affiliate of
The Rank Group Plc, and owner of Hard Rock Hotel Licensing, Inc. On April 25,
2006 the junior subordinated note was acquired by LUK-Ranch Entertainment, LLC
(LRE), a related party. Interest on the junior subordinated note accrues at a
rate of 15% per annum. Accrued interest at each semi annual interest payment
date of February 1 and August 1 is added to the principal balance to the extent
not paid. The Company will be required to pay a repayment premium of 3% of the
principal amount of the junior subordinated note when it is repaid. Such premium
is being accrued over the term of the junior subordinated note.
18
Premier Entertainment Biloxi LLC and Subsidiary
Debtor-In-Possession
Notes to Consolidated Financial Statements (continued)
7. LONG-TERM DEBT AND LOAN AND SECURITY AGREEMENT (CONTINUED)
IGT NOTE PAYABLE
On January 5, 2005, the Company entered into a Commercial Sales and Security
Agreement with IGT (the IGT Agreement) for the financing of certain gaming
devices and systems. Pursuant to the IGT Agreement, the Company purchased
approximately 1,100 slot devices from IGT, as well as software licenses and
related equipment for the gaming system. Under the IGT Agreement, interest
accrued at the "high Wall Street Journal prime lending rate" (8.25% at August 9,
2007) and payments were based on a 60-month amortization payable in thirty-six
monthly installments of principal and accrued interest with the balance due on
the thirty-seventh month (November 2008). IGT was named as a loss payee under
the Company's insurance policies. As a result of the bankruptcy, the amount due
under the IGT Agreement is classified as liabilities subject to compromise in
the accompanying consolidated statement of financial position. In accordance
with the Company's confirmed plan of reorganization, $7.6 million of principal,
accrued pre-petition interest at the contract rate, and post-petition accrued
interest at the reduced rate of 5.02% was paid on August 10, 2007. The remaining
balance of principal and accrued interest was paid October 10, 2007 (see Note
1).
SENIOR SECURED REDUCING LINE OF CREDIT FACILITY
On August 26, 2005, the Company received a $1.3 million loan from The Peoples
Bank pursuant to a $10.0 million Senior Secured Reducing Line of Credit Facility
(the Credit Facility). The Credit Facility was secured by a security interest in
certain collateral purchased by the Company and the lender was named as a loss
payee under the Company's blanket insurance policies. The Credit Facility had a
term of 66 months that included an initial funding period that ended on December
31, 2005.
Interest on the Credit Facility accrued at the rate of LIBOR plus 4.25% (9.7475%
at August 9, 2007). On December 31, 2005, the outstanding balance of the Credit
Facility was converted into a fully amortizing, five-year term loan due December
31, 2010, requiring quarterly payments of principal and interest. As a result of
the bankruptcy, the amounts due under the credit facility are classified as
liabilities subject to compromise in the accompanying consolidated statement of
financial position. In accordance with the Company's confirmed plan of
reorganization, the credit facility was paid in full, with post petition accrued
interest at the reduced rate of 7% per annum on August 10, 2007.
19
Premier Entertainment Biloxi LLC and Subsidiary
Debtor-In-Possession
Notes to Consolidated Financial Statements (continued)
7. LONG-TERM DEBT AND LOAN AND SECURITY AGREEMENT (CONTINUED)
BHR HOLDINGS, INC. FIXED RATE NOTE PAYABLE
On May 23, 2006, the Company received an $8.0 million loan from BHR, a related
party. An additional $0.1 million was received in September 2006. The note bears
interest at 12% per annum and the principal balance and all accrued and unpaid
interest is due on the earlier of May 23, 2007 or the date on which sufficient
insurance proceeds received from certain insurance carriers become available to
repay the note. Under the Fixed Rate Note, any interest not paid on the maturity
date shall be compounded by increasing the principal amount by the amount of
interest accrued through the maturity date. On May 23, 2007, $984,267 of accrued
and unpaid interest was added to the principal balance of the BHR Fixed Rate
Note. On February 26, 2008, the Company repaid the principal balance and accrued
interest due under the BHR Fixed Rate Note in full.
OTHER
On July 1, 2005, the Company obtained an Irrevocable Letter of Credit from The
Peoples Bank in favor of Hard Rock Hotel Licensing, Inc. in the amount of $1.0
million to comply with the terms and conditions of the Licensing Agreement with
Hard Rock Hotel Licensing, Inc. The Letter of Credit is secured by a certificate
of deposit in the amount of $1.0 million. The Letter of Credit reduces by
$100,000 on the first of each month beginning January 1, 2008 until it reaches
zero on October 1, 2008.
8. RELATED PARTY TRANSACTIONS
Roy Anderson, III a member of GAR, is the President, Chief Executive Officer and
majority stockholder of Roy Anderson Corp. (RAC), the Company's general
contractor.
In the aftermath of Hurricane Katrina, RAC performed remedial work in the amount
of $7.5 million, of which $2.9 million was outstanding and reflected in
liabilities subject to compromise in the August 9, 2007 consolidated statement
of financial position. In accordance with the Company's confirmed plan of
reorganization, this amount was paid in full with post petition interest as per
the Plan on September 30, 2007 (see Note 1).
On June 16, 2006, the Company entered into a $78.3 million guaranteed maximum
price construction agreement (Construction Agreement) with RAC to provide for
rebuilding the casino portion of the Hard Rock Biloxi and renovating and
repairing the existing hotel tower, low-rise building, parking garage and pool
20
Premier Entertainment Biloxi LLC and Subsidiary
Debtor-In-Possession
Notes to Consolidated Financial Statements (continued)
8. RELATED PARTY TRANSACTIONS (CONTINUED)
and deck area that were severely damaged by Hurricane Katrina. Deductive change
orders were issued on October 25, 2006, May 25, 2007, and October 10, 2007,
reducing the amount of the guaranteed maximum price to $73.0 million. During the
period from January 1, 2007 through August 9, 2007, $42.0 million was paid to
RAC under the Construction Agreement and $4.6 million is outstanding and
reflected in amounts due to related parties in the August 9, 2007 consolidated
statement of financial position. Subsequent to August 9, 2007, the $4.6 million
was paid to RAC.
On June 16, 2006, the Company entered into a receivables purchase agreement with
BHR and RAC. Pursuant to the terms of the receivables purchase agreement, BHR
agreed to purchase up to $40.0 million of receivables due to RAC by the Company
under the Construction Agreement if such receivables are past due for more than
ten days. As of August 9, 2007, $11.3 million of the amount due to RAC was paid
under this purchase agreement. The Company has reflected these amounts owing to
BHR as liabilities subject to compromise in the August 9, 2007 consolidated
statement of financial position. In accordance with the Company's confirmed plan
of reorganization, this amount was paid in full with post petition interest as
per the Plan on October 10, 2007 (see Note 1).
During the bankruptcy proceedings, LRE purchased certain third party claims
against the Company in the amount of $1.0 million. The Company has reflected
these amounts owing to LRE as liabilities subject to compromise in the August 9,
2007 consolidated statement of financial position. In accordance with the
Company's confirmed plan of reorganization, this amount was paid in full with
post petition interest as per the Plan on October 10, 2007 (see Note 1).
In 2006, in conjunction with a change of control of the Company's members, BHR
commenced a tender offer (the Offer) for all of the Company's outstanding
10 3/4% First Mortgage Notes at a price equal to 101% of the par value of the
Notes in satisfaction of the Company's obligation under the Indenture to make
such an offer upon the occurrence of a change of control as defined in the
Indenture. The offer expired with none of the Notes being tendered. In
connection with the Offer, GAR agreed to cause Premier to pay BHR a fee of $2.0
million, which will be paid only to the extent distributions from the Company
are available for such purpose. At August 9, 2007 the fee remains unpaid and is
included in amounts due to related parties on the consolidated statement of
financial position.
21
Premier Entertainment Biloxi LLC and Subsidiary
Debtor-In-Possession
Notes to Consolidated Financial Statements (continued)
8. RELATED PARTY TRANSACTIONS (CONTINUED)
In addition, the members of the Board of Managers of Premier are entitled to be
paid an annual management fee in an aggregate amount of $2.0 million, which will
be paid by Premier to the extent distributions from the Company are available
for such purpose. The Company began accruing for this fee on April 26, 2006 and
has accrued $2.6 million for this management fee in amounts due to related
parties on the August 9, 2007 consolidated statement of financial position.
As of August 9, 2007 LRE has paid $2.1 million of expenses on behalf of the
Company. Such amount is included in amounts due to related parties on the August
9, 2007 consolidated statement of financial position.
9. COMMITMENTS
OPERATING LEASES
The Company is committed under various operating lease agreements which were
assumed in the bankruptcy proceedings primarily related to property, submerged
tidelands and equipment. Generally, these leases include renewal provisions and
rental payments, which may be adjusted for taxes, insurance and maintenance
related to the property. Future minimum rental commitments under noncancelable
operating leases are as follows:
2007 $ 563,532
2008 1,358,660
2009 1,293,910
2010 1,293,940
2011 1,291,818
2012 1,294,135
Thereafter 27,762,291
-----------------------
$ 34,858,286
=======================
Total rent expense for these long-term lease obligations was $329,303 for the
period from January 1, 2007 through August 9, 2007.
22
Premier Entertainment Biloxi LLC and Subsidiary
Debtor-In-Possession
Notes to Consolidated Financial Statements (continued)
9. COMMITMENTS (CONTINUED)
In October 2003, the Company entered into an agreement with the State of
Mississippi for the lease and use of approximately 5 acres of submerged
tidelands. The term of the lease is for a period of 30 years. For the initial
period commencing on October 27, 2003 until the opening date as defined in the
agreement, the Company was required to pay annual rent of $21,900. From the
opening date through the remainder of the lease term, the lease rate was to be
determined as fair value on that date. In conjunction with the opening of the
casino, the revised lease rate is $985,000 annually. This rate will be adjusted
every five years based on the greater of the Consumer Price Index change for the
period or by appraisal of the fair market rent.
In November 2003, the Company entered into an agreement with the City of Biloxi,
Mississippi to lease property and the related airspace for a period of 40 years.
For the initial three years of the lease beginning in October 2004, the Company
must pay monthly rent of $12,500. The rent will increase by the Consumer Price
Index beginning on the fifth anniversary date of execution of the lease and
continuing on each fifth anniversary date.
Under the Hard Rock licensing agreement, the Company is obligated to pay an
annual lease fee of $150,000 for memorabilia displayed at the Hard Rock Biloxi.
The annual lease fee is fixed for the first two years and then adjusts
thereafter by the greater of 3% or an adjustment based on the inflation index,
but in no event shall such adjustment exceed 5% annually.
OTHER COMMITMENTS
Under the Hard Rock licensing agreement, the Company is obligated to pay an
annual fee of $1.1 million which increases to $1.5 million over five years and
increases annually thereafter based on the consumer price index, plus fees based
on future non-gaming revenues. The Company will pay a "Continuing Fee" equal to
three percent (3%) of the Licensing Fee Revenues and a marketing fee equal to
one percent (1%) of the Licensing Fee Revenues during the term of the agreement.
In no event shall these fees be construed so as to allow licensor to share in
any revenue generated by the Company's gaming operations. Fee expense under the
license agreement was $231,489 for the period from commencement of operations on
June 30, 2007 through August 9, 2007 and is included in other operating expenses
on the consolidated statement of operations and member's equity. In April 2006,
the Company agreed to accrue $150,000 per month in lieu of any other fees due
under the terms of the license agreement until such time that the operations
commence. Pursuant to this agreement, $900,000 was expensed during the period
from January 1, 2007 through June 30, 2007 and is included in preopening
expenses on the consolidated statement of operations and member's equity. At
August 9, 2007, $3.5 million has been accrued and recorded in other accrued
liabilities in the accompanying consolidated statement of financial position.
23
Premier Entertainment Biloxi LLC and Subsidiary
Debtor-In-Possession
Notes to Consolidated Financial Statements (continued)
9. COMMITMENTS (CONTINUED)
Such amounts were paid in full on November 30, 2007.
In December 2004, the Company entered into a lease which gives RCSH Operations,
LLC (RCSH) the right to operate a Ruth's Chris Steak House restaurant within the
Hard Rock Biloxi. The initial term is for ten years beginning July 1, 2007 and
RCSH has the right to extend the lease for four additional terms of five years
each. RCSH is obligated to pay minimum annual rent of $179,000 to the Company in
years one through five and $201,825 annually in years six through ten. In
addition to the minimum rent, RCSH is obligated to pay rent in the amount by
which 6% of RCSH's annual gross sales exceeds the minimum annual rent. Future
minimum rent payable to the Company under the lease with RCSH is as follows:
2007 $ 70,253
2008 179,000
2009 179,000
2010 179,000
2011 179,000
2012 190,413
Thereafter 908,213
-----------------------
$ 1,884,879
=======================
10. RECENTLY ISSUED ACCOUNTING STANDARDS
SFAS NO. 159 In February 2007, the FASB issued SFAS No. 159, "The Fair Value
Option for Financial Assets and Financial Liabilities--Including an Amendment of
FASB Statement No. 115," which permits entities to choose to measure many
financial instruments and certain other items at fair value. SFAS No. 159 will
become effective for the Company on January 1, 2008 (the first fiscal year
beginning after November 15, 2007). The Company is currently evaluating the
impact of adopting SFAS No. 159 but does not expect that the adoption will have
a material impact on its consolidated financial statements.
24
Premier Entertainment Biloxi LLC and Subsidiary
Debtor-In-Possession
Notes to Consolidated Financial Statements (continued)
10. RECENTLY ISSUED ACCOUNTING STANDARDS (CONTINUED)
SFAS NO. 157 In September 2006, the FASB issued SFAS No. 157, "Fair Value
Measurements." The statement defines fair value, establishes a framework for
measuring fair value, expands disclosures about fair value measurements and does
not require any new fair value measurements. SFAS No. 157 will become effective
for the Company on January 1, 2008 (the first fiscal year beginning after
November 15, 2007). In February 2008, the FASB decided to issue final Staff
Positions that will partially defer the effective date of SFAS No. 157 for one
year for certain nonfinancial assets and nonfinancial liabilities and remove
certain leasing transactions from the scope of SFAS No. 157. The Company is
currently evaluating the impact of adopting SFAS No. 157 but does not expect
that the adoption will have a material impact on its consolidated financial
statements
11. FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used to estimate the fair value of
each class of financial instruments for which it is practical to estimate that
value:
o Cash and cash equivalents - The carrying amounts approximate fair
value because of the short maturity of these instruments.
o Restricted cash - The carrying amounts approximate fair value
because of the short maturity of these instruments.
o Long-term debt - As a result of the bankruptcy filing, the fair
value of the Company's long-term debt as of August 9, 2007 cannot be
estimated. As a result, the fair value is presented at its carrying
value. Debt obligations with a short remaining maturity are valued
at the carrying amount.
25
Premier Entertainment Biloxi LLC and Subsidiary
Debtor-In-Possession
Notes to Consolidated Financial Statements (continued)
11. FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
The estimated carrying amounts and fair values of the Company's financial
instruments at August 9, 2007 are as follows:
--------------------------------------
CARRYING FAIR
AMOUNT VALUE
--------------------------------------
FINANCIAL ASSETS:
Cash and cash equivalents $ 17,158,856 $ 17,158,856
Restricted cash 40,662,134 40,662,134
FINANCIAL LIABILITIES:
10 3/4% First mortgage notes 160,000,000 160,000,000
15% Junior subordinated note 16,730,358 16,730,358
IGT note payable 12,870,932 12,870,932
Senior secured reducing line of
credit facility 1,250,000 1,250,000
BHR note payable 9,084,267 9,084,267
26
HFH SHORTPLUS FUND, L.P.
(A DELAWARE LIMITED PARTNERSHIP)
FINANCIAL STATEMENTS
DECEMBER 31, 2007
A CLAIM OF EXEMPTION FROM CERTAIN REGULATORY REQUIREMENTS
HAS BEEN MADE TO THE COMMODITY FUTURES TRADING COMMISSION
PURSUANT TO COMMISSION REGULATION 4.7 BY THE COMMODITY
POOL OPERATOR OF HFH SHORTPLUS FUND, L.P.
HFH SHORTPLUS FUND, L.P.
(A DELAWARE LIMITED PARTNERSHIP)
INDEX
DECEMBER 31, 2007
--------------------------------------------------------------------------------
11
PAGE(S)
REPORT OF INDEPENDENT AUDITORS.............................................1
FINANCIAL STATEMENTS
Statement of Assets, Liabilities and Partners' Capital.....................2
Statement of Operations and Special Allocation.............................3
Statement of Changes in Partners' Capital..................................4
Statement of Cash Flows....................................................5
Financial Highlights.......................................................6
Notes to Financial Statements...........................................7-10
Affirmation of the Commodity Pool Operator................................11
REPORT OF INDEPENDENT AUDITORS
To the General Partner and Limited Partners of
HFH ShortPLUS Fund, L.P.
In our opinion, the accompanying statement of assets, liabilities, and partners'
capital and the related statements of operations and special allocation, of
changes in partners' capital, of cash flows and financial highlights present
fairly, in all material respects, the financial position of HFH ShortPLUS Fund,
L.P. (the "Partnership") at December 31, 2007, and the results of its
operations, the changes in its partners' capital, its cash flows and the
financial highlights for the year then ended, in conformity with accounting
principles generally accepted in the United States of America. These financial
statements and financial highlights (hereinafter referred to as the "financial
statements") are the responsibility of the General Partner. Our responsibility
is to express an opinion on these financial statements based on our audit. We
conducted our audit of these financial statements in accordance with auditing
standards generally accepted in the United States of America. Those standards
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by the General Partner, and evaluating the
overall financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
/s/ PricewaterhouseCoopers
March 17, 2008
1
HFH SHORTPLUS FUND, L.P.
(A DELAWARE LIMITED PARTNERSHIP)
STATEMENT OF ASSETS, LIABILITIES AND PARTNERS' CAPITAL
DECEMBER 31, 2007
--------------------------------------------------------------------------------
(expressed in U.S. dollars)
ASSETS
Investment in HFH ShortPLUS Master Fund, Ltd. $83,923,831
Cash and cash equivalents 5,958,995
Other assets 140
-----------
Total assets $89,882,966
===========
LIABILITIES
Accrued expenses and other liabilities $ 22,501
-----------
Total liabilities 22,501
-----------
PARTNERS' CAPITAL 89,860,465
-----------
Total liabilities and partners' capital $89,882,966
===========
The accompanying notes are an integral part of these financial statements.
2
HFH SHORTPLUS FUND, L.P.
(A DELAWARE LIMITED PARTNERSHIP)
STATEMENT OF OPERATIONS AND SPECIAL ALLOCATION
YEAR ENDED DECEMBER 31, 2007
--------------------------------------------------------------------------------
(expressed in U.S. dollars)
NET INVESTMENT INCOME ALLOCATED FROM HFH SHORTPLUS MASTER FUND, LTD.
Income $ 3,798,885
Expense (1,523,828)
------------
2,275,057
------------
PARTNERSHIP INVESTMENT INCOME
Interest 10,538
------------
Total income 2,285,595
PARTNERSHIP EXPENSES
Management fee 416,360
Professional fees 30,000
------------
Total expenses 446,360
------------
Net investment income 1,839,235
------------
REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS ALLOCATED FROM HFH SHORTPLUS
MASTER FUND, LTD.
Net realized gains on investments and derivatives 26,147,378
Net change in unrealized appreciation on investments and derivatives 38,016,188
------------
Net realized and unrealized gains on investments and derivatives 64,163,566
------------
Net increase in partners' capital resulting from operations 66,002,801
Profit Reallocation to General Partner 6,561,910
------------
Net income available for pro-rata distribution to all partners $ 59,440,891
============
The accompanying notes are an integral part of these financial statements.
3
HFH SHORTPLUS FUND, L.P.
(A DELAWARE LIMITED PARTNERSHIP)
STATEMENT OF CHANGES IN PARTNERS' CAPITAL
YEAR ENDED DECEMBER 31, 2007
--------------------------------------------------------------------------------
(expressed in U.S. dollars)
GENERAL LIMITED
PARTNER PARTNERS TOTAL
------------ ------------ ------------
Balance, January 2, 2007 $ -- $ -- $ --
Capital contributions 1,000 39,965,569 39,966,569
Capital withdrawals -- (16,108,905) (16,108,905)
Increase in partners' capital resulting from operations
Pro rata allocation 2,448 66,000,353 66,002,801
Incentive allocation 6,561,910 (6,561,910) --
------------ ------------ ------------
BALANCE, DECEMBER 31, 2007 $ 6,565,358 $ 83,295,107 $ 89,860,465
============ ============ ============
The accompanying notes are an integral part of these financial statements.
4
HFH SHORTPLUS FUND, L.P.
(A DELAWARE LIMITED PARTNERSHIP)
STATEMENT OF CASH FLOWS
YEAR ENDED DECEMBER 31, 2007
--------------------------------------------------------------------------------
(expressed in U.S. dollars)
Net increase in partners' capital resulting from operations $ 66,002,801
Adjustments to reconcile net increase in partners' capital resulting
from operations to net cash used in operating activities
Investment in HFH ShortPLUS Master Fund, Ltd. (39,961,486)
Withdrawal from HFH ShortPLUS Master Fund, Ltd. 22,476,276
Income from Master Fund (66,438,621)
Increase in other assets (140)
Increase in accrued expenses and other liabilities 22,501
------------
Net cash used in operating activities (17,898,669)
------------
Cash provided from financing activities
Partners' capital contributions 39,966,569
Partners' capital withdrawals (16,108,905)
------------
Net cash provided by financing activities 23,857,664
Net increase in cash and cash equivalents 5,958,995
Cash
Beginning of year --
------------
End of year $ 5,958,995
============
The accompanying notes are an integral part of these financial statements.
5
HFH SHORTPLUS FUND, L.P.
(A DELAWARE LIMITED PARTNERSHIP)
FINANCIAL HIGHLIGHTS
YEAR ENDED DECEMBER 31, 2007
--------------------------------------------------------------------------------
(expressed in U.S. dollars)
The financial highlights table represents the Partnership's financial
performance for the year ended December 31, 2007 as follows:
LIMITED PARTNERS
Total return before incentive allocation 242.28%
Incentive allocation (34.15)
----------
Total return after incentive allocation(a) 208.13%
==========
Net investment income ratio(b) 3.51%
Operating expense ratio(c) (3.77)%
Incentive allocation (12.54)
----------
Total expenses and incentive allocation (16.31)%
==========
Operating expense ratio excluding interest expense(d) (1.20)%
==========
(a) Total return is calculated for aggregate limited partners' capital,
exclusive of the General Partner, taken as a whole and adjusted for
cash flows related to capital contributions and withdrawals during
the year. An individual limited partner's return may differ
depending on the timing of contributions and withdrawals, as well
as varying fee structures.
(b) The net investment income ratio is based on the net investment
income allocated to a limited partner prior to the effect of an
incentive allocation and is exclusive of unrealized and realized
gains and losses. The net investment income ratio attributable to
an individual partner's account may vary based on timing of capital
transactions.
(c) The operating expense ratio is based on the expenses allocated to
each partner prior to the effects of any incentive allocation. For
the purpose of this calculation, operating expenses include
expenses incurred by the Partnership directly as well as expenses
allocated from the Master Fund. Expense ratios are calculated over
average net assets. Expense ratio excluding the effect of allocated
expenses from the Master Fund would be (0.85%). The expense ratios
attributable to an individual partner's account may vary based on
different management fee and incentive allocation arrangements and
the timing of capital transactions.
(d) The operating expense ratio is based on the expenses allocated to
each partner. For the purpose of this calculation, operating
expenses include expenses incurred by the Partnership directly as
well as expenses allocated from the Master Fund, excluding interest
expense. Expense ratios are calculated over average net assets. The
expense ratios attributable to an individual partner's account may
vary based on different fee arrangements and the timing of capital
transactions.
The accompanying notes are an integral part of these financial statements.
6
HFH SHORTPLUS FUND, L.P.
(A DELAWARE LIMITED PARTNERSHIP)
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2007
--------------------------------------------------------------------------------
1. ORGANIZATION
Highland ShortPLUS Fund, L.P. (the "Partnership") is a Delaware limited
partnership and commenced operations on January 2, 2007. The Partnership
invests substantially all of its investable assets through a
"master-feeder" structure in HFH ShortPLUS Master Fund, Ltd. ("Master
Fund"), a Cayman Islands exempted company that invests and trades a
short-biased portfolio of asset-backed securities ("ABS") that the
Investment Manager believes are most likely to produce high returns
during periods of adverse credit performance for residential mortgages,
and for mortgage-backed securities ("MBS") and ABS. Returns will come
from two principal sources: (i) market value changes, arising from
changes in credit spreads on the Master Fund's short positions; and (ii)
credit default payments from counterparties on credit default swaps
("CDS") or other derivatives in credit sensitive mortgage and
asset-backed securities, consumer debt and other assets. The
Partnership's investment objective is the same as that of the Master
Fund. The financial statements of the Master Fund are included elsewhere
in this report and should be read in conjunction with the Partnership's
financial statements. Highland Financial Holdings, LLC (the "General
Partner") serves as the general partner and Highland Financial Holdings
Group, LLC ("Investment Manager") serves as the investment manager of
the Partnership.
The Master Fund is also managed by the Investment Manager. Valuation of
the investments held by the Master Fund is discussed in the notes to the
financial statements included elsewhere in this report. The percentage
of the Master Fund's net assets owned by the Partnership at December 31,
2007 was approximately 26.1%.
2. SUMMARY OF SELECTED SIGNIFICANT ACCOUNTING POLICIES
USE OF ESTIMATES
The financial statements are prepared in accordance with accounting
principles generally accepted in the United States of America ("U.S.
GAAP"). The preparation of financial statements in accordance with U.S.
GAAP requires management to make estimates and assumptions that affect
the reported amounts and disclosures in the financial statements. Actual
results could differ from these estimates.
BASIS OF ACCOUNTING
The Fund records security and contractual transactions, if any, on a
trade/contractual date basis.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents consist principally of cash and short term
investments (overnight bank investments), which are readily convertible
into cash and have original maturities of three months or less.
VALUATION
The Partnership records its investment in the Master Fund at fair value
based on the net asset value of the Master Fund. Valuation of financial
instruments by the Master Fund is discussed in Note 2 of the Master
Fund's Notes.
INCOME AND EXPENSE RECOGNITION
The Partnership records its proportionate share of the Master Fund's
investment income/loss, expenses and realized and unrealized gains and
losses. The Master Fund's income and expense recognition and allocations
policies are discussed in Note 2 of the Master Fund's Notes.
7
HFH SHORTPLUS FUND, L.P.
(A DELAWARE LIMITED PARTNERSHIP)
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2007
--------------------------------------------------------------------------------
Interest income of the Partnership's cash balance is accrued as earned.
Expenses that are directly attributable to the Partnership are recorded
on the accrual basis as incurred.
INCOME TAXES
The Partnership is not a taxable entity for federal, state or local
income tax purposes; such taxes are the responsibility of individual
partners. Accordingly, no provision has been made in the accompanying
financial statements for any federal, state or local income taxes.
On February 1, 2008, FASB issued FIN 48-2, Effective Date of FASB
Interpretation No. 48 for Certain Nonpublic Enterprises ("FSP"), which
allows the Partnership to defer the adoption of FIN 48 until periods
beginning after December 15, 2007. The General Partner has elected to
take advantage of this deferral. Based on its analysis, the General
Partner has determined that the adoption of FIN 48 will not have a
material impact to the Partnership's financial statements. However, the
General Partner's conclusions regarding FIN 48 may be subject to review
and adjustment at a later date based on factors including, but not
limited to, further implementation guidance, and on-going analyses of
tax laws, regulations and interpretations thereof.
FIN 48 requires the General Partner to determine whether a tax position
of the Partnership is more likely than not to be sustained upon
examination by the applicable taxing authority, including resolution of
any related appeals or litigation processes, based on the technical
merits of the position. The tax benefit to be recognized is measured as
the largest amount of benefit that is greater than fifty percent likely
of being realized upon ultimate settlement which could result in the
Partnership recording a tax liability that would reduce partners'
capital. FIN 48 must be applied to all existing tax positions upon
initial adoption and the cumulative effect, if any, is to be reported as
an adjustment to partners' capital upon adoption.
3. CONTRIBUTIONS AND WITHDRAWALS
The minimum initial and subsequent capital contributions (each a
"Capital Contribution") in the Partnership are $5,000,000 and
$1,000,000, respectively. The Investment Manager may waive or reduce the
minimum Capital Contributions in its sole discretion. The General
Partner may admit new Limited Partners and permit Limited Partners to
make additional Capital Contributions as of the first business day of
each calendar month, or at any other time in the General Partner's sole
discretion.
Subject to the lock-up period and early withdrawal fee, Limited Partners
shall have the right to require the Partnership to withdraw all or any
portion of their investment by delivering written notice to the General
Partner not less than 90 days prior to the end of any calendar quarter,
or at such other times as the General Partner determines in its sole
discretion. The General Partner reserves the right to waive or reduce
the notice period in its sole discretion. Notwithstanding anything to
the contrary, a Limited Partner may not withdraw each Capital
Contribution (and any appreciation thereon) until after the 12 month
period (the "Lock-up Period") following the date of such contribution,
without the prior consent of the General Partner, which may be granted
or denied in the General Partner's sole discretion.
Limited Partners who withdraw a Capital Contribution after the Lock-up
Period with respect to such Capital Contribution but less than 24 months
after purchasing such Capital Contribution will be charged an early
withdrawal fee equal to 5% of the withdrawal amount. Any early
withdrawal fee will be payable to the Partnership. The General Partner
reserves the right, in its sole discretion, to waive or reduce the early
withdrawal fee on a case-by-case basis. Subject to the Partnership's
8
HFH SHORTPLUS FUND, L.P.
(A DELAWARE LIMITED PARTNERSHIP)
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2007
--------------------------------------------------------------------------------
right to establish reserves, a minimum of 95% of the withdrawals
proceeds will generally be paid to the withdrawing Limited Partner
within 15 business days after the corresponding withdrawal date, with
the balance payable (without interest) within 90 days of the
corresponding withdrawal date. The General Partner, at its discretion,
reserves the right to suspend or limit redemptions.
In the event that withdrawal requests are received representing in the
aggregate more than 10% of the total Net Asset Value of the Partnership
on any withdrawal date, the Partnership is entitled to reduce ratably
and pro rata amongst all Limited Partners seeking to withdraw interests
on the withdrawal date and to carry out only sufficient withdrawals,
which in the aggregate, amount to 10% of the total Net Asset Value of
the Partnership on such withdrawal date.
4. ALLOCATION OF NET INCOME (LOSS) AND INCENTIVE ALLOCATION
Net investment income and gains and losses are allocated to the partners
on a monthly basis, based on the partners' proportionate share of
capital in the Partnership at the beginning of the month.
The General Partner receives an incentive allocation equal to 20% of
such net income (includes net realized and unrealized gains and losses)
which will be deducted from the capital account of such limited partner
and reallocated to the General Partner's capital account. Such incentive
allocation is earned at December 31 of each year or when withdrawals
occur. At the discretion of the General Partner, this rate may be
reduced for certain Limited Partners. If there is a loss for the fiscal
period, such loss is carried forward to future periods and no
allocations will be made to the General Partner until prior fiscal
period losses are recovered. For the year ended December 31, 2007, the
General Partner was allocated $6,561,910 in incentive allocations.
5. MANAGEMENT FEE AND OTHER RELATED PARTY TRANSACTIONS
The Investment Manager receives a quarterly management fee
prospectively, equal to 0.50% (2% per annum) of each Limited Partner's
capital account. At the discretion of the General Partner, this rate may
be reduced for certain Limited Partners and affiliated fund investments.
For the year ended December 31, 2007, the Investment Manager earned a
management fee of $416,360 from the Partnership.
For the year ended December 31, 2007, an affiliated party contributed
$13,365,569 of capital and made $16,108,905 of withdrawals. At December
31, 2007, the principal officers and employees of the Investment
Manager, either directly or through family members and affiliated
entities, had $296,785 invested in the Partnership.
6. OFF-BALANCE SHEET RISK, LEVERAGE AND CONCENTRATION OF CREDIT RISKS
Off-balance sheet risk, leverage and concentration of credit risks are
discussed in the Master Fund's Notes.
Due to the nature of the master fund/feeder fund structure, the
Partnership could be materially affected by significant subscriptions
and redemptions of the other feeder fund. From time to time, the
Partnership may have a concentration of partners holding a significant
percentage of the Partnership's partners' capital. Investment activities
of these partners could have a material impact on the Partnership. At
December 31, 2007, one partner individually owned approximately 95% of
the total partners' capital.
9
HFH SHORTPLUS FUND, L.P.
(A DELAWARE LIMITED PARTNERSHIP)
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2007
--------------------------------------------------------------------------------
7. WITHDRAWALS PAYABLE
In accordance with FASB Statement No. 150, Accounting for Certain
Financial Instruments with Characteristics of Both Liabilities and
Equity, as effected by FASB Staff Position No. FAS 150-3, withdrawals
are recognized as liabilities by the Partnership, net of incentive
allocations, when the amount requested in the withdrawal notice becomes
fixed. This generally occurs either at the time of the receipt of the
notice, or on the last day of a fiscal period, depending on the nature
of the request. As a result, withdrawals paid after the end of the year,
but based upon year-end capital balances are reflected as withdrawals
payable at December 31, 2007. Withdrawal notices received for which the
dollar amount is not fixed remains in capital until the amount is
determined. Withdrawals payable may be treated as capital for purposes
of allocations of gains/losses pursuant to the Partnership's governing
documents.
The Partnership has received withdrawal notices for which the dollar
amounts are not fixed as of December 31, 2007. As such, associated
amounts have remained in capital and are not reflected as withdrawals
payable. There is no capital subject to withdrawal notices for amounts
that are fixed and determinable as of December 31, 2007.
8. CONTINGENCIES AND COMMITMENTS
In the normal course of business, the Partnership enters into contracts
that contain a variety of representations, warranties and general
indemnifications. The Partnership's maximum exposure under these
arrangements, including future claims that may be made against the
Partnership that have not yet occurred, is unknown. However, based on
experience of the General Partner, the Partnership expects the risk of
loss associated with such contracts to be remote.
9. SUBSEQUENT EVENTS
As of December 31, 2007 and through March 1, 2008, the Partnership
received requests for withdrawals, including amounts which are not
currently fixed and determinable, amounting to approximately $4,000,938.
All these withdrawal requests will be recorded subsequent to March 1,
2008, in accordance with the Partnership's withdrawal notice
requirements.
In September 2006, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 157, Fair Value
Measurements ("SFAS 157"). SFAS 157 defines fair value, establishes a
framework for measuring fair value, and expands disclosures about fair
value measurements. SFAS 157 applies to reporting periods beginning
after November 15, 2007. The adoption of SFAS 157 is not expected to
have a material impact on the Fund's financial statements.
10
AFFIRMATION OF COMMODITY POOL OPERATOR
To the best of my knowledge and belief the information contained herein
pertaining to HFH ShortPLUS Fund, L.P. is accurate and complete.
Highland Financial Holdings, LLC
Commodity Pool Operator
/s/ Paul Ullman
-------------------------------------------
By Paul Ullman
President of Highland Financial
Holdings, LLC, General Partner of HFH
ShortPLUS Fund, L.P.
11
HFH SHORTPLUS MASTER
FUND, LTD.
(A CAYMAN ISLANDS EXEMPTED COMPANY)
FINANCIAL STATEMENTS
DECEMBER 31, 2007
A CLAIM OF EXEMPTION FROM CERTAIN REGULATORY REQUIREMENTS
HAS BEEN MADE TO THE COMMODITY FUTURES TRADING COMMISSION
PURSUANT TO COMMISSION REGULATION 4.7 BY THE COMMODITY POOL
OPERATOR OF HFH SHORTPLUS MASTER FUND, LTD.
HFH SHORTPLUS MASTER FUND, LTD.
(A CAYMAN ISLANDS EXEMPTED COMPANY)
INDEX
DECEMBER 31, 2007
--------------------------------------------------------------------------------
PAGE(S)
REPORT OF INDEPENDENT AUDITORS..............................................1
FINANCIAL STATEMENTS
Statement of Assets and Liabilities.........................................2
Schedule of Investments...................................................3-7
Statement of Operations.....................................................8
Statement of Changes in Net Assets..........................................9
Statement of Cash Flows....................................................10
Financial Highlights.......................................................11
Notes to Financial Statements...........................................12-20
Affirmation of the Commodity Pool Operator.................................21
REPORT OF INDEPENDENT AUDITORS
To the Board of Directors and Shareholders of
HFH ShortPLUS Master Fund, Ltd.
In our opinion, the accompanying statement of assets and liabilities, including
the schedule of investments, and the related statements of operations, of
changes in net assets, of cash flows and financial highlights present fairly, in
all material respects, the financial position of HFH ShortPLUS Master Fund, Ltd.
(the "Fund") at December 31, 2007, and the results of its operations, the
changes in its net assets, its cash flows and the financial highlights for the
year then ended, in conformity with accounting principles generally accepted in
the United States of America. These financial statements and financial
highlights (hereinafter referred to as the "financial statements") are the
responsibility of the Fund's management. Our responsibility is to express an
opinion on these financial statements based on our audit. We conducted our audit
of these financial statements in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
/s/ PricewaterhouseCoopers
March 17, 2008
1
HFH SHORTPLUS MASTER FUND, LTD.
(A CAYMAN ISLANDS EXEMPTED COMPANY)
STATEMENT OF ASSETS AND LIABILITIES
DECEMBER 31, 2007
--------------------------------------------------------------------------------
(expressed in U.S. dollars)
ASSETS
Investments, at value $ 12,296,717
------------
Total investments, at value (cost $ 73,670,861) 12,296,717
Cash and cash equivalents 250,938,764
Margin cash paid to counterparties 1,800,244
Securities purchased under agreements to resell 59,174,000
Credit default swap contracts, at value (upfront fee payments $79,349,003) 271,421,697
Interest receivable 126,085
Other assets 89,134
------------
Total assets $595,846,641
------------
LIABILITIES
Margin cash received from counterparties $218,648,130
Credit default swap contracts, at value (upfront fee receipts $39,723,958) 54,612,639
Due to brokers (Note 3) 95,483
Interest payable on margin cash 953,919
Accrued expenses and other liabilities 233,750
------------
Total liabilities 274,543,921
------------
Net assets (5,000,000 common shares authorized, $0.01 par value;
931.50 shares issued and outstanding) $321,302,720
============
Net asset value per share disclosures are made in the financial highlights.
The accompanying notes are an integral part of these financial statements.
2
HFH SHORTPLUS MASTER FUND, LTD.
(A CAYMAN ISLANDS EXEMPTED COMPANY)
SCHEDULE OF INVESTMENTS
DECEMBER 31, 2007
--------------------------------------------------------------------------------
(expressed in U.S. dollars)
CURRENT FACE / COUPON
NOTIONAL DESCRIPTION RATE MATURITY VALUE
Asset Backed Securities -
Fixed Rate Home Equity (0.27%)
$ 707,099 TMTS 04-8HES B2 8.000% 6/25/2034 $ 595,872
1,990,000 MASD 07-1 B1 5.250% 1/25/2037 104,475
3,482,000 MASD 07-1 B2 5.250% 1/25/2037 182,805
-----------
Total Asset Backed Securities -
Fixed Rate Home Equity
(cost $ 5,306,332) 883,152
-----------
ASSET BACKED SECURITIES -
FLOATING RATE HOME EQUITY (0.21%)
1,977,237 BAYVIEW FINANCIAL TR 2004-D 8.355% 8/28/2044 284,426
1,893,631 QUEST 2006-X1 M5 7.365% 3/25/2036 94,682
2,476,000 QUEST 2006-X2 M9 7.365% 8/25/2036 173,320
2,539,341 QUEST 2006-X2 M10 7.365% 8/25/2036 126,967
-----------
Total Asset Backed Securities -
Floating Rate Home Equity
(cost $ 8,263,205) 679,395
-----------
ASSET BACKED SECURITIES -
FIXED RATE HOME EQUITY NIM (0.40%)
2,218,243 CWALN 2006-0C8 N 7.750% 2/25/2037 420,539
6,171,417 GSAMP 07 FM1N N1 6.000% 12/25/2036 433,323
4,950,000 HASCN 06-OPT1 B 8.000% 12/26/2035 80,437
5,740,685 NHELN 07-2 N1 NIM 7.385% 1/25/2037 287,034
5,900,000 SBFT 05-HE3 N2 144A * 6.500% 9/25/2035 77,466
-----------
Total Asset Backed Securities -
Fixed Rate Home Equity NIM
(cost $ 23,132,410) 1,298,799
-----------
ASSET BACKED SECURITIES - FLOATING
RATE BUSINESS LOANS (2.41%)
738,720 BAYC 05-3A B3 7.865% 11/25/2035 470,587
7,060,000 BAYVIEW COML MTG TR 2006-SP1 8.865% 4/25/2036 3,591,775
4,178,000 LBSBN 2007-1 N2 8.500% 3/27/2037 3,676,640
-----------
Total Asset Backed Securities -
Floating Rate Business Loans
(cost $ 11,414,997) 7,739,002
-----------
PREFERRED ASSET BACKED SECURITIES - FLOATING
SHARES RATE CDO (0.03%)
2,000,000 BUCKINGHAM CDO III LTD 2007-3 0.000% 9/5/2051 20,000
8,000 CITATION HGH GRD ABS CDO I LTD PFD
3C7 144A *# 6.000% 1/15/2035 80,000
-----------
Total Asset Backed Securities -
Floating Rate CDO (cost $ 6,981,641) 100,000
-----------
The accompanying notes are an integral part of these financial statements.
3
HFH SHORTPLUS MASTER FUND, LTD.
(A CAYMAN ISLANDS EXEMPTED COMPANY)
SCHEDULE OF INVESTMENTS
DECEMBER 31, 2007
--------------------------------------------------------------------------------
(expressed in U.S. dollars)
NOTIONAL/
PREFERRED COUPON
SHARES DESCRIPTION RATE MATURITY VALUE
ASSET BACKED SECURITIES -
HOME EQUITY RESIDUALS (0.50%)
$ 2,351,781 CMLTI 2006-HE1 CE 0.000% 1/25/2036 $ 250,000
18 CMLTI 2006-HE1 P 0.000% 1/25/2036 275,000
24,000 GSAMP 2006 RES - PREFERRED 0.000% N/A 999,999
2,469,540 MANM 07-1 1N2 5.873% 1/25/2047 71,370
5,514,200 MANM 07-1 1N3 7.373% 1/25/2047 -
------------
Total Asset Backed Securities -
Home Equity Residuals
(cost $ 18,572,276) 1,596,369
------------
Total Investments
(cost $ 73,670,861) $ 12,296,717
------------
* 144A securities are exempt from registration under Rule 144A of
the Securities Act of 1933. These securities may only be resold
to qualified institutional buyers.
# Citation is an entity that is advised by Highland Financial
Holdings Group, LLC, the Fund's Investment Manager, and
accordingly is considered an affiliate.
CREDIT
DEFAULT SWAP
NOTIONAL TERMINATION CONTRACTS,
AMOUNT CREDIT DEFAULT SWAP CONTRACTS, AT VALUE (-17.00%) DATE AT VALUE
$(10,000,000) SAIL 2006-4 M4 (BEAR pays 5.80%) 6/25/2036 $ (6,851,192)
(10,000,000) RAMP 2005-EFC6 M9 (BEAR pays 5.85%) 11/25/2035 (6,576,706)
(7,500,000) BNC07001 M8 (UBS pays 5.75%) 3/25/2037 (5,232,031)
(6,000,000) HASC 2006 -OPT1 M9 (DB pays 7.45%) 12/25/2035 (4,291,400)
(5,000,000) RFC06NC3 M8 (CITI pays 5.00%) 3/25/2036 (3,759,223)
(5,000,000) SAST 06-1 B3 (GS pays 6.55%) 3/25/2036 (3,086,684)
(5,000,000) RFC05KS9 M8 (UBS pays 5.60%) 10/25/2035 (2,772,204)
(5,000,000) WLT05WC1 M9 (GS pays 7.30%) 10/25/2035 (2,762,035)
(5,000,000) SABR 2005-FR2 B2 (LEH pays 3.20%) 3/25/2035 (2,815,630)
(5,000,000) LBML0502 M8 (GS pays 4.90%) 4/25/2035 (2,589,105)
(5,000,000) CWL 2006 -15 (CS pays 6.25%) 8/25/2042 (2,879,129)
(5,000,000) RFC06KS2 M8 (GS pays 5.75%) 3/25/2036 (3,661,476)
(5,000,000) CMLTI 2006-HE1 M8 (DB pays 2.11%) 1/25/2036 (3,807,247)
(5,000,000) WMLT 2005-WMC1 M9 (CS pays 7.30%) 10/25/2035 (2,778,257)
(2,000,000) FFML 2005-FF2 B3 (GS pays 3.75%) 3/25/2035 (750,320)
------------
Credit Default Swap Contracts, at Value -
(upfront fee receipts: $ 39,723,958) $(54,612,639)
The accompanying notes are an integral part of these financial statements.
4
HFH SHORTPLUS MASTER FUND, LTD.
(A CAYMAN ISLANDS EXEMPTED COMPANY)
SCHEDULE OF INVESTMENTS
DECEMBER 31, 2007
--------------------------------------------------------------------------------
(expressed in U.S. dollars)
CREDIT
DEFAULT SWAP
NOTIONAL TERMINATION CONTRACTS,
AMOUNT CREDIT DEFAULT SWAP CONTRACTS, AT VALUE (84.48%) DATE AT VALUE
$ 2,000,000 FFML 2005-FF2 B3 (Pay GS 1.70%) 3/25/2035 $ 751,087
3,350,000 JPMAC 2005-FRE1 MP (Pay DB 7.00%) 10/25/2035 1,978,175
4,000,000 FFML 2004-FF8 B3 (Pay CS 2.00%) 10/25/2034 596,458
4,000,000 RFC06NC3 M9 (Pay CITI 7.50%) 3/25/2036 2,604,830
4,000,000 RFC06KS8 M5 (Pay GS 1.10%) 10/25/2036 2,739,291
4,000,000 FFML06F5 M9 (Pay CITI 3.35%) 4/25/2036 3,309,590
5,000,000 SAMI 2006-AR1 B6 (Pay CS 3.00%) 2/25/2036 3,035,000
5,000,000 CWE0626 M7 (Pay UBS 2.30%) 5/25/2037 2,877,000
5,000,000 HEAT0607 B1 (Pay CS 5.35%) 1/25/2037 3,820,443
5,000,000 FFML 2006 - FF12 M9 (Pay CITI 3.00%) 9/25/2036 4,161,633
5,000,000 ARS06W01 M9 (Pay GS 2.42%) 3/25/2036 3,924,809
5,000,000 RFC06NC2 M9 (Pay GS 2.42%) 2/25/2036 4,137,900
5,000,000 NFHE0603 M6 (Pay GS 0.98%) 10/25/2036 3,505,230
5,000,000 NFHE0603 M8 (Pay UBS 2.23%) 10/25/2036 3,739,510
5,000,000 RASC 2006-KS3 M9 (Pay GS 2.42%) 4/25/2036 4,074,810
5,000,000 NCHET 2005-D M8 (Pay GS 1.70%) 2/25/2036 2,991,500
5,000,000 ACE 06-OP1 M8 (Pay GS 2.25%) 3/25/2036 4,076,989
5,000,000 MSAC 2006-HE2 B3 (Pay GS 2.42%) 3/25/2036 4,331,125
5,000,000 BSABS 2006-EC2 M9 (Pay GS 3.50%) 2/25/2036 3,987,429
5,000,000 MAB06AM2 M9 (Pay CS 4.50%) 6/25/2036 4,210,759
5,000,000 MLMI 2005-HE1 B3 (Pay GS 1.24%) 3/25/2037 4,015,848
5,000,000 SABR 2005-FR2 B2 (Pay UBS 1.92%) 3/25/2035 2,822,047
5,000,000 LBML0502 M8 (Pay CITI 2.40%) 4/25/2035 2,601,605
5,000,000 CMLTI 2006-HE1 M8 (Pay GS 2.11%) 1/25/2036 3,820,448
5,000,000 RFC05KS9 M8 (Pay UBS 3.50%) 10/25/2035 2,782,715
5,000,000 CWHE0615 B (Pay ML 4.75%) 10/25/2046 2,886,629
5,000,000 CHEC06A M9 (Pay CITI 2.87%) 6/25/2036 3,097,201
5,000,000 SAST 06-1 B3 (Pay UBS 4.30%) 3/25/2036 3,097,934
5,000,000 RFC06EM8 M5 (Pay GS 1.50%) 10/25/2036 3,173,000
5,000,000 ACCT0601 M9 (Pay GS 2.17%) 4/25/2036 3,217,315
5,000,000 ACCT0601 M9 (Pay CS 3.72%) 4/25/2036 3,209,565
5,000,000 CWHE0614 M8 (Pay CITI 6.90%) 2/25/2037 3,315,500
5,000,000 CWHE0610 MV9 (Pay CITI 8.50%) 9/25/2046 3,440,023
5,000,000 SVHE06E1 M9 (Pay CITI 5.75%) 10/25/2036 3,511,748
5,000,000 FFM07FF1 B1 (Pay CITI 3.10%) 1/25/2038 3,627,912
5,000,000 RFC06KS2 M8 (Pay CITI 2.50%) 3/25/2036 3,677,726
5,000,000 RASC 2007-KS2 M8 (Pay GS 2.80%) 2/25/2037 3,740,497
5,000,000 BSABS 2007-HE2 2M8 (Pay GS 3.25%) 3/25/2037 3,873,094
5,000,000 GSA06HE7 M9 (Pay CITI 5.50%) 10/25/2036 3,888,971
5,000,000 FFML 06-FF6 M6 (Pay GS 2.65%) 4/25/2036 3,934,604
5,000,000 RASC 2007-KS2 M8 (Pay GS 3.25%) 2/25/2037 3,950,383
5,000,000 ACE06OP1 M9 (Pay DB 3.25%) 4/25/2036 4,109,693
5,000,000 GSA06HE7 M9 (Pay GS 5.80%) 10/25/2036 4,120,351
The accompanying notes are an integral part of these financial statements.
5
HFH SHORTPLUS MASTER FUND, LTD.
(A CAYMAN ISLANDS EXEMPTED COMPANY)
SCHEDULE OF INVESTMENTS
DECEMBER 31, 2007
--------------------------------------------------------------------------------
(expressed in U.S. dollars)
CREDIT
DEFAULT SWAP
NOTIONAL TERMINATION CONTRACTS,
AMOUNT CREDIT DEFAULT SWAP CONTRACTS, AT VALUE (84.48%) DATE AT VALUE
$ 5,000,000 CWHE0619 M9 (Pay CITI 3.35%) 3/25/2037 $ 4,216,615
6,000,000 CWL 2006-26 M9 (Pay CS 4.79%) 6/25/2037 4,762,222
6,000,000 HSA06OP1 M9 (Pay GS 3.80%) 12/25/2035 4,323,348
6,250,000 RFC06EF1 M8 (Pay UBS 2.45%) 4/25/2036 4,047,188
7,500,000 CWL 2006 - 22 M8 (Pay CS 5.00%) 5/25/2037 5,876,598
7,500,000 CWABS INC 2006-26 (Pay GS 2.75%) 8/25/2037 5,697,813
7,500,000 OOMLT0503 M9 (Pay GS 10.25%) 8/25/2035 4,562,982
7,500,000 BNC07001 M8 (Pay UBS 3.53%) 3/25/2037 5,223,525
7,500,000 FFM07FF1 B2 (Pay UBS 5.25%) 1/25/2038 5,255,116
7,500,000 FFM06F17 M8 (Pay UBS 5.53%) 12/25/2036 6,018,409
7,500,000 FFM06F15 M8 (Pay CITI 5.43%) 11/25/2036 6,261,120
10,000,000 FFM07FF1 B2 (Pay UBS 3.10%) 1/25/2038 5,429,476
10,000,000 NOVASTAR MTG FDG TR 2006-5 (Pay UBS 3.14%) 11/25/2036 7,167,728
10,000,000 SAIL 2006-4 M4 (Pay CS 3.75%) 7/25/2036 6,849,220
10,000,000 WLT05WC1 M9 (Pay BEAR 5.05%) 10/25/2035 5,546,570
10,000,000 RFC05EF6 M9 (Pay CITI 3.80%) 11/25/2035 6,537,957
10,000,000 CWHE0610 MV9 (Pay BEAR 8.25%) 9/25/2046 6,951,296
10,000,000 OOMLT0603 M8 (Pay UBS 4.78%) 2/25/2037 7,741,132
10,000,000 SAS06EQ1 M8 (Pay UBS 1.60%) 7/25/2036 7,834,000
10,000,000 FFM06F17 M8 (Pay DB 2.90%) 12/25/2036 8,187,489
10,000,000 FFM06F12 M8 (Pay UBS 5.42%) 9/25/2036 8,163,516
------------
Credit Default Swap Contracts, at Value -
(upfront fee payments: $ 79,349,003) $271,421,697
------------
Total Net Credit Default Swap Contracts, at Value $216,809,058
------------
The accompanying notes are an integral part of these financial statements.
6
HFH SHORTPLUS MASTER FUND, LTD.
(A CAYMAN ISLANDS EXEMPTED COMPANY)
SCHEDULE OF INVESTMENTS
DECEMBER 31, 2007
--------------------------------------------------------------------------------
(expressed in U.S. dollars)
SECURITIES PURCHASED UNDER AGREEMENTS TO RESELL
DAYS TO REPURCHASE
COUNTERPARTY RATE MATURITY AGREEMENT TOTAL
Bear Stearns 4.60% 2 $ 59,174,000
-------------
Total $ 59,174,000
-------------
The accompanying notes are an integral part of these financial statements.
7
HFH SHORTPLUS MASTER FUND, LTD.
(A CAYMAN ISLANDS EXEMPTED COMPANY)
STATEMENT OF OPERATIONS
YEAR ENDED DECEMBER 31, 2007
--------------------------------------------------------------------------------
(expressed in U.S. dollars)
INVESTMENT INCOME
Interest (includes interest from an affiliated investment of $427,870) $ 11,304,208
Dividends 1,257,011
-------------
Total investment income 12,561,219
INVESTMENT EXPENSE
Interest 4,935,004
-------------
OTHER EXPENSES
Custody fees 62,530
Professional fees 308,250
Administration fees 141,333
Director fees 17,160
Other expenses 6,352
-------------
Total other expenses 535,625
-------------
Total expenses 5,470,629
-------------
Net investment income 7,090,590
-------------
NET REALIZED AND UNREALIZED GAIN (LOSS)
Net realized gain (loss) on
Investments (8,247,891)
Swap contracts 107,929,188
-------------
Net realized gain 99,681,297
-------------
Net change in unrealized appreciation/(depreciation) on
Investments (includes depreciation from an affiliated investment of $5,160,391) (61,374,144)
Swap contracts 178,219,519
-------------
Net change in unrealized appreciation 116,845,375
-------------
Net realized and unrealized gain 216,526,672
-------------
Net increase in net assets resulting from operations $ 223,617,262
=============
The accompanying notes are an integral part of these financial statements.
8
HFH SHORTPLUS MASTER FUND, LTD.
(A CAYMAN ISLANDS EXEMPTED COMPANY)
STATEMENT OF CHANGES IN NET ASSETS
YEAR ENDED DECEMBER 31, 2007
--------------------------------------------------------------------------------
(expressed in U.S. dollars)
FROM OPERATIONS
Net investment income $ 7,090,590
Net realized gain 99,681,297
Net change in unrealized appreciation 116,845,375
-------------
Net increase in net assets resulting from operations 223,617,262
-------------
FROM CAPITAL SHARE TRANSACTIONS
Subscriptions 135,380,623
Redemptions (37,695,165)
-------------
Net increase in net assets resulting from capital share transactions 97,685,458
-------------
Total increase in net assets 321,302,720
NET ASSETS
Beginning of year --
-------------
End of year $ 321,302,720
-------------
The accompanying notes are an integral part of these financial statements.
9
HFH SHORTPLUS MASTER FUND, LTD.
(A CAYMAN ISLANDS EXEMPTED COMPANY)
STATEMENT OF CASH FLOWS
YEAR ENDED DECEMBER 31, 2007
--------------------------------------------------------------------------------
(expressed in U.S. dollars)
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $ 223,617,262
Adjustments to reconcile net increase in net assets resulting from
operations to net cash provided from operating activities
Purchase of investment securities (111,312,492)
Purchase of credit default swaps (87,793,098)
Proceeds from dispositions of investment securities
(including paydowns) 29,393,740
Proceeds from dispositions of credit default swaps 156,097,241
Net realized (gain)/loss on investments 8,247,891
Net realized (gain)/loss on swap contracts (107,929,188)
Net change in unrealized depreciation on investments 61,374,144
Change in net value of swap contracts (177,184,013)
Change in margin cash received from counterparties 218,648,130
Change in margin cash paid to counterparties (1,800,244)
Change in securities purchased under agreements to resell (59,174,000)
Change in interest receivable (126,085)
Change in interest payable on margin cash 953,919
Change in accrued expenses and other liabilities 233,750
Change in due to brokers 95,483
Change in other assets (89,134)
-------------
Net cash provided from operating activities 153,253,306
-------------
CASH PROVIDED FROM FINANCING ACTIVITIES
Capital subscriptions 135,380,623
Capital redemptions (37,695,165)
-------------
Net cash provided from financing activities 97,685,458
-------------
Net change in cash and cash equivalents 250,938,764
CASH AND CASH EQUIVALENTS
Beginning of year --
-------------
End of year $ 250,938,764
=============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Interest paid $ 3,981,085
=============
The accompanying notes are an integral part of these financial statements.
10
HFH SHORTPLUS MASTER FUND, LTD.
(A CAYMAN ISLANDS EXEMPTED COMPANY)
FINANCIAL HIGHLIGHTS
YEAR ENDED DECEMBER 31, 2007
--------------------------------------------------------------------------------
(expressed in U.S. dollars)
Results of operations for a share outstanding for the year ended December 31,
2007 are as follows:
Per share operating performance(a)
NET ASSET VALUE PER SHARE, BEGINNING OF YEAR $ 100,000.00
Net investment income 7,873.42
Net realized and unrealized gain 237,056.11
--------------
NET ASSET VALUE PER SHARE, END OF YEAR $ 344,929.53
==============
Total return(b) 244.93%
RATIOS TO AVERAGE NET ASSETS
Operating expense(c) (3.34)%
Operating expense excluding interest expense(c) (0.33)%
Net investment income(c) 4.33%
(a) Per share operating performance is computed based upon the monthly
outstanding shares.
(b) Total return is calculated for a share outstanding the entire year. An
individual shareholder's return may differ depending on the timing of
subscriptions and redemptions.
(c) The operating expense and net investment income ratios are calculated for
the Fund taken as a whole. An individual shareholder's ratio may vary from
these ratios based on the timing of capital transactions.
The accompanying notes are an integral part of these financial statements.
11
HFH SHORTPLUS MASTER FUND, LTD.
(A CAYMAN ISLANDS EXEMPTED COMPANY)
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2007
--------------------------------------------------------------------------------
1. ORGANIZATION AND INVESTMENT OBJECTIVE
HFH ShortPLUS Master Fund, Ltd. (the "Fund") is a Cayman Islands
exempted company incorporated in accordance with the Companies Law (2004
revision) which commenced operations on January 2, 2007. The Fund's
strategy is to assemble a short-biased portfolio of asset-backed
securities ("ABS") that the Investment Manager believes are most likely
to produce high returns during periods of adverse credit performance for
residential mortgages, and for mortgage-backed securities ("MBS") and
ABS. Returns will come from two principal sources: (i) market value
changes arising from changes in credit spreads on the Fund's short
positions; and (ii) credit default payments from counterparties on
credit default swaps ("CDS") or other derivatives.
Highland Financial Holdings Group, LLC ("Investment Manager") serves as
the investment manager of the Fund. The Investment Manager manages and
invests the Fund's assets and effects all security transactions on
behalf of the Fund.
The Fund operates under a "master fund/feeder fund" structure. HFH
ShortPLUS Fund, Ltd. and HFH ShortPLUS Fund, L.P. (collectively, the
"Feeder Funds") invest substantially all of their investable assets in
the Fund. The following Feeder Funds were invested in the Fund at
December 31, 2007:
HFH ShortPLUS Fund, Ltd. $237,378,889
HFH ShortPLUS Fund, L.P. 83,923,831
------------
Total Feeder Funds' investment in the Fund $321,302,720
------------
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
USE OF ESTIMATES
The financial statements are prepared in accordance with accounting
principles generally accepted in the United States of America ("U.S.
GAAP"). The preparation of financial statements in accordance with U.S.
GAAP requires management to make estimates and assumptions, including
estimates of fair value investments and CDS, that affect the reported
amounts and disclosures in the financial statements. Actual results
could differ from these estimates and those differences could be
material to the financial statements.
BASIS OF ACCOUNTING
Transactions in securities are recorded on a trade date basis. Realized
and unrealized gains/losses are calculated based on a FIFO cost basis.
Interest income is recorded on an accrual basis when earned. Operating
expenses, including interest on securities sold short, margin deposits,
and reverse repurchase agreements, are recorded on the accrual basis as
incurred.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents consist principally of cash, margin cash
received from counterparties, and short term investments (treasury
bills), which are readily convertible into cash and have original
maturities of three months or less.
12
HFH SHORTPLUS MASTER FUND, LTD.
(A CAYMAN ISLANDS EXEMPTED COMPANY)
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2007
--------------------------------------------------------------------------------
VALUATION
Investments in securities held by the Fund are carried at value. Value
for such investments is estimated by the Investment Manager. The
Investment Manager will use its reasonable discretion to value each
investment by using, as a guide, a combination of (i) independent,
third-party pricing sources; (ii) indications from one or more financial
institutions engaged in trading the investments or securities similar to
the investments being valued; (iii) transactions in the market of the
same or similar securities; and (iv) in-house models the Investment
Manager maintains. In cases where the number of indications is limited,
the Investment Manager will review other factors such as the previous
month's value, whether such indication is from the same counterparty,
the delta between the current value and the previous month value,
relevant market data or news, the value of similar securities, recent
trading information and any other information which may be deemed
relevant at the discretion of the Investment Manager. With respect to
CDS, the Investment Manager may use, if considered representative of the
value of CDS positions, margin marks from the actual counterparty with
whom the security was traded, or from counterparties of a similar CDS
position to estimate the valuation. However, if the Investment Manager
believes the exit price will be either greater or less than the current
margin mark, the Investment Manager has the discretion to revise the
value accordingly.
Fair value determinations based on indications from financial
institutions or margin marks from counterparties may be based on as few
as a single indication/margin mark, or may be calculated as the average
of more than one such indication/margin mark, which average may include
recent transactions in the market or ignore outlying indications/margin
marks based on the Investment Manager's discretion. The Investment
Manager may use observable transactions in the market in determining the
fair value of investments if, at the discretion of the Investment
Manager, prioritization of such transactions is considered more relevant
given market conditions or other factors. Securities for which no
indications are available are to be valued at such value as the
Investment Manager may reasonably determine.
The Investment Manager defines investments that are fair valued as those
investments for which an investment is valued solely based on an
in-house maintained model. As of December 31, 2007, these financial
statements include investments fair valued by such in-house model
totaling $4,705,836 (1.5% of net assets). In addition, the Investment
Manager has determined that conditions in the 2007 asset backed
securities market have impacted the extent of relevant data points that
are available to estimate fair value of the Fund's investments. These
market conditions include reduced liquidity, increased risk premiums for
issuers, reduced investor demand for asset-backed securities,
particularly those securities backed by sub-prime collateral, general
financial stress and rating agency downgrades, and a general tightening
of available credit. At December 31, 2007, the values for approximately
$7,507,552 (2.3% of net assets) of investments, $176,174,662 (54.8% of
net assets) of CDS "receiving" protection, and -$3,759,223 (-1.2% of net
assets) of CDS "providing" protection were primarily estimated using one
indication/margin mark obtained from an external source. Given market
conditions described above, the indication/margin mark provided by
financial institutions may differ from the bid or ask that market
participants would be willing to transact. As a result, the range of
fair value of investments and CDS positions can be significant and the
values reflected in these financial statements may differ from the
values that would have been realized had such investments been
liquidated.
Options that are listed on or admitted to trading on one or more
exchanges are valued at the last sale price, if such price is equal to
or is between, the "bid" and the "ask" prices (otherwise, the mean
between the "bid" and "ask" prices is used). If options are not listed
or admitted to trading on one or more exchanges, the fair value of such
options is obtained from external parties which may include the contract
13
HFH SHORTPLUS MASTER FUND, LTD.
(A CAYMAN ISLANDS EXEMPTED COMPANY)
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2007
--------------------------------------------------------------------------------
counterparty. Future contracts traded on a national exchange or market
are valued at the last reported sales price on the valuation date.
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
The Fund recognizes the market value of all derivative instruments as
either assets or liabilities in the Statement of Assets and Liabilities
and measures those instruments at fair value.
INTEREST RATE AND INDEX SWAPS
The Fund may enter into interest rate and index swaps as part of its
investment strategies. Swaps involve the exchange by the Fund with
another party of respective commitments to pay or receive interest,
effective return, or total return throughout the lives of the
agreements. The Fund may be required to deliver or receive cash or
securities as collateral upon entering into swap transactions. Movements
in the relative value of the swap transactions may require the Fund or
the counterparty to post additional collateral. Swaps change in value
with movements in interest rates. During the term of the swap contracts,
changes in value and accrued interest payments are recognized as
unrealized gains or losses by marking the contracts to the market. These
unrealized gains and losses are reported as an asset or liability,
respectively, on the Statement of Assets and Liabilities. When contracts
are terminated, the Fund will realize a gain or loss equal to the
difference between the proceeds from (or cost of) the closing
transaction and the Fund's basis in the contract, if any.
CREDIT DEFAULT SWAPS
The Fund enters into credit default swaps to simulate long and short
bond positions that are either unavailable or considered to be less
attractively priced in the bond market. The Fund uses these swaps to
attempt to reduce risk where the Fund has exposure to the issuer, or to
take an active long or short position with respect to the likelihood of
the issuer's default. There is no certainty that the objectives of
holding credit default swaps will be achieved.
The buyer of a credit default swap is obligated to pay the seller a
periodic stream of payments over the term of the contract in return for
a contingent payment upon the occurrence of a credit event, with respect
to an underlying reference obligation. Generally, a credit event means
bankruptcy, failure to pay, obligation accelerated or modified
restructuring. If a credit event occurs, the seller typically must pay
the contingent payment to the buyer, which is typically the par value
(full notional value) of the reference obligation. The contingent
payment may be a cash settlement or by a physical delivery of the
reference obligation in return for payment of the face amount of the
obligation. If the Fund is a buyer and no credit event occurs, the Fund
may lose its investment and recover nothing. However, if a credit event
occurs, the buyer typically receives full notional value and interest
for a reference obligation that may have little or no value. As a
seller, the Fund receives a fixed rate of income throughout the term of
the contract, provided that no credit event occurs. If a credit event
occurs, the seller may pay the buyer the full notional value and
interest of the reference obligation. Upfront payments made and/or
received by the Fund are recorded as an asset and/or liability on the
Statement of Assets and Liabilities and are recorded as a realized gain
or loss on the termination date.
As of December 31, 2007, the Fund has 79 open credit default swaps. The
Fund is the buyer on 64 of these swaps ("receiving protection" on a
total notional amount of $382.1 million) and is the seller on the
remaining 15 ("providing protection" on a total notional amount of $85.5
million).
Credit default swaps involve greater risks than if the Fund had invested
in the reference obligations directly. In addition to general market
risks, credit default swaps are subject to liquidity risk and
counterparty credit risk. A buyer also may lose its investment and
recover nothing should a credit event not occur. If a credit event did
14
HFH SHORTPLUS MASTER FUND, LTD.
(A CAYMAN ISLANDS EXEMPTED COMPANY)
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2007
--------------------------------------------------------------------------------
occur, the value of the reference obligation received by the seller,
coupled with the periodic payments previously received, may be less than
the full notional value it pays to the buyer, resulting in a loss of
value.
The notional amounts of the swaps are not recorded in the financial
statements. The swaps are carried at their estimated fair value, as
determined in good faith by the Investment Manager. The change in value
is recorded within unrealized appreciation (depreciation) until the
occurrence of a credit event or the termination of the swap, at which
time a realized gain (loss) is recorded.
FUTURES
A futures contract is an agreement between two parties to buy or sell a
financial instrument for a set price on a future date. Initial margin
deposits are made upon entering into futures contracts and can be either
cash or securities. During the period the futures contract is open,
changes in the value of the contract are recognized as unrealized gains
or losses by marking to market on a daily basis to reflect the market
value of the contract at the end of each day's trading. When the
contract is closed, the Fund records a realized gain or loss equal to
the difference between the proceeds of the closing transaction and the
Fund's basis in the contract.
PURCHASED OPTIONS
The Fund may purchase put or call options. When the Fund purchases an
option, an amount equal to the premium paid is recorded as an asset and
is subsequently marked-to-market. Premiums paid for purchasing options
that expire unexercised are recognized on the expiration date as
realized losses. If an option is exercised, the premium paid is
subtracted from the proceeds of the sale or added to the cost of the
purchase to determine whether the Fund has realized a gain or loss on
the related investment transaction. When the Fund enters into a closing
transaction, the Fund will realize a gain or loss depending upon whether
the amount from the closing transaction is greater or less than the
premium paid.
WRITTEN OPTIONS
The Fund may write put or call options. When the Fund writes an option,
an amount equal to the premium received is recorded as a liability and
is subsequently marked-to-market. Premiums received for writing options
that expire unexercised are recognized on the expiration date as
realized gains. If an option is exercised, the premium received is
subtracted from the cost of the purchase or added to the proceeds of the
sale to determine whether the account has realized a gain or loss on the
related investment transaction. When the Fund enters into a closing
transaction, the Fund will realize a gain or loss depending upon whether
the amount from the closing transaction is less or greater than the
premium received.
SHORT SALES
When the Fund sells short, it may borrow the security sold short and
deliver it to the broker-dealer through which it sold short as
collateral for its obligation to deliver the security upon conclusion of
the sale. Additionally, the Fund generally is required to deliver cash
or securities as collateral for the Fund's obligation to return the
borrowed security. The Fund may have to pay a fee to borrow the
particular securities and may be obligated to pay over any payments
received on such borrowed securities. A gain, limited to the price at
which the Fund sold the security short, or a loss, unlimited as to
dollar amount, will be recognized upon the termination of a short sale
if the market price is less or greater than the proceeds originally
received.
15
HFH SHORTPLUS MASTER FUND, LTD.
(A CAYMAN ISLANDS EXEMPTED COMPANY)
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2007
--------------------------------------------------------------------------------
FINANCING TRANSACTIONS
The Fund enters into repurchase agreements as a borrower (securities
sold under agreement to repurchase) and as a lender (securities
purchased under agreement to resell). All repurchase agreements are
carried at their contractual amounts on the Statement of Assets and
Liabilities, and the accrued income (expense) is recorded separately.
Securities sold under agreements to repurchase include buy-sell
financing transactions.
SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
("REVERSE REPURCHASE AGREEMENTS")
The Fund monitors collateral market values relative to the amounts due
under the agreements, including accrued interest, throughout the lives
of the agreements, and when necessary, requires transfer of cash or
securities in order to manage exposure and liquidity. In connection with
such agreements, if the counterparty defaults or enters an insolvency
proceeding, realization or return of the collateral to the Fund may be
delayed or limited.
At December 31, 2007, the Fund had no securities sold under agreements
to repurchase.
SECURITIES PURCHASED UNDER AGREEMENTS TO RESELL ("REPURCHASE
AGREEMENTS")
Securities purchased under agreements to resell are generally
collateralized principally by U.S. government and agency securities. The
Fund takes possession of such underlying collateral, monitors its market
value relative to the amounts due under the agreements, including
accrued interest, throughout the lives of the agreements, and when
necessary, may require a transfer of additional cash or securities in
order to manage exposure and liquidity. In connection with such
agreements, if the counterparty defaults or enters an insolvency
proceeding, realization or return of the funds to the Fund may be
delayed or limited.
At December 31, 2007, the Fund had securities purchased under agreements
to resell totaling $59,174,000. The Fund received collateral in the form
of various FNMA MBS pools under a held in custody agreement with an
interest rate of 4.6% and a maturity of two days. The value of the
securities, including accrued interest, received as collateral by the
Fund that it was permitted to sell or repledge was $59,189,122.
INCOME TAXES
The Fund is a Cayman Islands exempted company. Under the current laws of
the Cayman Islands, there are no income, estate, transfer, sale or other
taxes payable by the Fund. The Fund is taxed as a partnership for U.S.
Federal income tax purposes, and as such, is not subject to income
taxes; each investor may be individually liable for income taxes, if
any, on its share of the Fund's net taxable income. The Fund trades
securities for its own account and, as such, investors are generally not
subject to U.S. tax on such earnings (other than certain withholding
taxes indicated below). The Investment Manager intends to conduct the
business of the Fund to the maximum extent practicable so that the
Fund's activities do not constitute a U.S. trade or business. Interest
and other income received by the Fund from sources within the United
States may be subject to, and reflected net of, United States
withholding tax at the rate of 30%. Interest, dividend and other income
realized by the Fund from non-U.S. sources and capital gains realized on
the sale of securities of non-U.S. issuers may be subject to withholding
and other taxes levied by the jurisdiction in which the income is
sourced.
On February 1, 2008, FASB issued FIN 48-2, Effective Date of FASB
Interpretation No. 48 for Certain Nonpublic Enterprises ("FSP"), which
allows the Fund to defer the adoption of FIN 48 until periods beginning
after December 15, 2007. The Investment Manager has elected to take
advantage of this deferral. Based on its analysis, the Investment
Manager has determined that the adoption of FIN 48 will not have a
16
HFH SHORTPLUS MASTER FUND, LTD.
(A CAYMAN ISLANDS EXEMPTED COMPANY)
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2007
--------------------------------------------------------------------------------
material impact to the Fund's financial statements. However, the
Investment Manager's conclusions regarding FIN 48 may be subject to
review and adjustment at a later date based on factors including, but
not limited to, further implementation guidance, and on-going analyses
of tax laws, regulations and interpretations thereof.
FIN 48 requires the Investment Manager to determine whether a tax
position of the Fund is more likely than not to be sustained upon
examination by the applicable taxing authority, including resolution of
any related appeals or litigation processes, based on the technical
merits of the position. The tax benefit to be recognized is measured as
the largest amount of benefit that is greater than fifty percent likely
of being realized upon ultimate settlement which could result in the
Fund recording a tax liability that would reduce net assets. FIN 48 must
be applied to all existing tax positions upon initial adoption and the
cumulative effect, if any, is to be reported as an adjustment to net
assets upon adoption.
3. DUE TO/FROM BROKERS
The Fund has brokerage agreements with various brokerage firms to carry
its account as a customer. The brokers have custody of the Fund's
securities and, from time to time, cash balances may be due to/from
these brokers.
These securities and/or cash positions serve as collateral for any
amounts due to brokers or as collateral for securities sold, not yet
purchased or investment securities purchased on margin. The securities
and/or cash positions also serve as collateral for potential defaults of
the Fund.
The Fund is subject to credit risk if the brokers are unable to repay
balances due or deliver securities in their custody.
4. FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK AND OTHER RISKS
The Fund may invest on a leveraged basis in various financial
instruments and is exposed to market risks resulting from changes in the
fair value of the instruments. The Statement of Assets and Liabilities
may include the market or fair value of contractual commitments
involving forward settlements, futures contracts and swap transactions
as well as investments in securities sold short. These instruments
involve elements of market risk in excess of amounts reflected on the
Statement of Assets and Liabilities. Derivative financial statements are
used by the Fund to help manage such market risk and to take an active
long or short position in the market. Should interest rates move
unexpectedly, the Fund may not achieve the anticipated benefits of the
hedging instruments and may realize a loss. Further, the use of such
derivative instruments involves the risk of imperfect correlation in
movements in the price of the instruments, interest rates and the
underlying hedged assets.
The investment characteristics of mortgage-backed and asset-backed
securities differ from traditional debt securities. Among the major
differences are that interest and principal payments are made more
frequently, usually monthly, and that principal may be prepaid at any
time because the underlying residential or commercial mortgage loans or
other assets generally may be prepaid at any time. Maturities on
mortgage-backed and asset-backed securities represent stated maturity
dates. Actual maturity dates may differ based on prepayment rates.
The Fund is exposed to credit-related losses in the event of
nonperformance by counterparties to financial instruments. The maximum
credit exposure related to the derivative financial instruments of the
17
HFH SHORTPLUS MASTER FUND, LTD.
(A CAYMAN ISLANDS EXEMPTED COMPANY)
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2007
--------------------------------------------------------------------------------
Fund is equal to the fair value of the contracts with positive fair
values as of December 31, 2007. It is the policy of the Fund to transact
the majority of its securities and contractual commitment activity with
broker-dealers, banks and regulated exchanges that the Investment
Manager considers to be well established.
The Fund's short-biased strategy depends in large measure upon the
ability of the Investment Manager to identify ABS that experience future
credit losses arising from the defaults by obligors on the related
mortgage loans. This is the opposite approach from that employed in
traditional long-bias credit investment strategies that generally seek
to avoid credit losses on investments purchased on the basis of
fundamental credit analysis, or on other bases.
There can be no assurance that the Investment Manager's assessments of
the likelihood of default and losses on specific ABS transactions will
be accurate or that the predictive strengths of the Investment Manager's
models and practices will not decline. Even if ABS default and loss
rates increase generally in the future relative to the rates observed in
the past, the Fund's return objectives will not be met if the Fund has
bought credit protection or otherwise shorted securities that do not
experience such higher default and loss rates.
The Fund's strategy also includes long investments that are intended to
generate positive income during the first several years of the Fund, in
order to partially offset the negative carry of the short positions.
Losses on these long positions could produce losses for the Fund and
could result in the failure of the Fund to achieve the intended purpose
of offsetting the CDS premium costs.
The Fund is a new enterprise with limited operating history.
Accordingly, an investment in the Fund entails risk. There can be no
assurance that the Fund will achieve its investment objective or that
the Fund's strategies will be successful. There exists a possibility
that an investor could suffer a substantial loss as a result of an
investment in the Fund.
The success of any investment activity is influenced by general economic
conditions that may affect the level and volatility of equity prices,
credit spreads, interest rates and the extent and timing of investor
participation in the markets for both equity and interest-rate-sensitive
securities. Unexpected volatility or illiquidity in the markets in which
the Fund directly or indirectly holds positions could impair the Fund's
ability to carry out its business and could cause the Fund to incur
losses.
Depending on market conditions, reliable pricing information will not
always be available from any source. Prices quoted by different sources
are subject to material variation.
Credit-sensitive tranches of ABS are exposed to credit risk arising from
possible defaults of the underlying loans and recovery rates on those
liquidated loans. The default rates of loans backing these securities is
dependent on a number of factors including the quality and
characteristics of the loans, national and regional economic growth,
real estate values, the level of interest rates, changes in the
availability of mortgage financing and other factors. Recovery values
following a default will be dependent largely on regional and national
real estate values among other things; although real estate values may
depend on other economic variables.
The rate of prepayments on the loans collateralizing a subordinate ABS
tranche will generally have a significant effect on the amount of
obligor defaults a tranche can face before suffering losses of interest
or principal. The Investment Manager believes it is impossible to
accurately predict prepayment rates because prepayment rates are heavily
influenced by equally unpredictable interest rates. Consequently, while
18
HFH SHORTPLUS MASTER FUND, LTD.
(A CAYMAN ISLANDS EXEMPTED COMPANY)
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2007
--------------------------------------------------------------------------------
the Investment Manager seeks to explore the potential effects of a wide
range of possible prepayment rates for securities or CDS it purchases or
sells, there can be no assurance that this analysis will exhaust the
possible paths prepayments could take, or that the effects of any
particular prepayment rate scenario will be evaluated correctly in
respect of a specific ABS tranche or CDS.
A decline in the market value of the Fund's portfolio of assets may
limit the Investment Manager's ability to borrow, or may result in
lenders initiating margin calls (i.e., requiring a pledge of cash or
additional assets to re-establish the ratio of the amount of the
borrowing to the value of the collateral). The Investment Manager could
be required to sell assets at distressed prices under adverse market
conditions in order to satisfy the requirements of the lenders. A
default by the Fund under its collateralized borrowings could also
result in a liquidation of the collateral by the lender, including any
cross-collateralized assets, and a resulting loss of the difference
between the value of the collateral and the amount borrowed.
As discussed in Note 1, the Fund's investors are two Feeder Funds
managed by the Investment Manager. The Fund could be materially affected
by significant subscriptions and redemptions from the underlying
investors of these Feeder Funds.
5. SHARE CAPITAL
The authorized share capital of the Fund consists of 5,000,000 shares
having a par value of $0.01 (U.S.) per share. At December 31, 2007,
931.50 shares were issued and outstanding.
Common shares are offered at an offering price equal to the net asset
value per common share as of the close of business on the immediately
preceding business day.
Any holder of common shares has the right, in accordance with and
subject to the applicable provisions of the memorandum of association of
the Fund and the laws of the Cayman Islands, to have all or a portion of
their shares redeemed on a date determined by the Directors.
At December 31, 2007, all outstanding shares are held by the Feeder
Funds.
The following table reconciles share transactions for the year ended
December 31, 2007:
SHARES
Balance, January 2, 2007 --
Shares issued 1,150.86
Shares redeemed (219.36)
-----------
BALANCE, DECEMBER 31, 2007 931.50
===========
The Directors of the Fund have the sole discretion to authorize
distribution of dividends.
6. DIRECTORS AND FEES
The following persons are independent non-executive Directors of the
Fund:
o David Bree
19
HFH SHORTPLUS MASTER FUND, LTD.
(A CAYMAN ISLANDS EXEMPTED COMPANY)
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2007
--------------------------------------------------------------------------------
o Peter Burnim
All members of the Board of Directors are reimbursed for their
out-of-pocket expenses incurred in connection with the performance of
their duties and each receives an annual fee of approximately $5,000. No
Directors have a shareholder interest in the Fund or have an interest,
direct or indirect, in any transaction affecting the Fund during the
year ended December 31, 2007, which is unusual in nature or significant
to the business of the Fund. No Director has any contracts of
significance with the Fund.
7. CONTINGENCIES AND COMMITMENTS
In the normal course of business, the Fund enters into contracts that
contain a variety of representations, warranties and general
indemnifications. The Fund's maximum exposure under these arrangements,
including future claims that may be made against the Fund that have not
yet occurred, is unknown. However, based on experience of the Investment
Manager, the Fund expects the risk of loss associated with such
contracts to be remote.
8. RELATED PARTY TRANSACTIONS
The Investment Manager provides discretionary services to other funds
that follow an investment program similar to that which was followed by
the Fund. Investments may be allocated between the Fund and other funds.
Also, the Fund may purchase securities from and sell securities to such
other funds. No additional transaction costs are incurred by the Fund as
a result of such transactions. The Investment Manager allocates certain
expenses to the Fund for the day-to-day accounting and administrative
services performed by its employees on behalf of the Fund. For the
year-ended December 31, 2007, these costs amounted to $163,588. These
costs are included in the Fund's "professional expenses" on the
statement of operations.
9. SUBSEQUENT EVENTS
From January 1 through March 1, 2008, the Fund had redemptions of
$33,617,455.
In September 2006, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 157, Fair Value
Measurements ("SFAS 157"). SFAS 157 defines fair value, establishes a
framework for measuring fair value, and expands disclosures about fair
value measurements. SFAS 157 applies to reporting periods beginning
after November 15, 2007. The adoption of SFAS 157 is not expected to
have a material impact on the Fund's financial statements.
20
AFFIRMATION OF COMMODITY POOL OPERATOR
To the best of my knowledge and belief the information contained herein
pertaining to HFH ShortPLUS Master Fund, Ltd. is accurate and complete.
Highland Financial Holdings Group, LLC
Commodity Pool Operator
/s/ Paul Ullman
------------------------------------------
By Paul Ullman
President of Highland Financial Holdings
Group, LLC The Investment Manager of
Highland ShortPLUS Master Fund, Ltd.
21